To What Extent Can Czech Exporters Cushion Exchange Rate Shocks through Imported Inputs?

This paper examines the role of imported inputs in cushioning exchange rate shocks by using a partial equilibrium model of heterogeneous firms. Producers in the model can serve the domestic market, export final goods, import inputs or engage in both exporting and importing. In the model, an exogenous exchange rate shock simultaneously affects the variable costs and revenues associated with exports and imports. The impact of a hypothetical 1% appreciation of the domestic currency on sales is estimated using a panel of 7,356 Czech manufacturing firms observed from 2003 to 2006. We focus on the above period to exploit the rich within-firm variation in trade strategies. This variation is likely to be associated with the lifting of trade barriers following the Czech Republic’s EU accession in 2004. For firms that both export and import, the model predicts a drop in export sales of 0.8% as opposed to a 1% drop for price-taker exporters who do not use imported inputs.