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Multinationals and Exchange Rate Pass-Through

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  • Alexandra Lai
  • Oana Secrieru

Abstract

The authors examine the impact of multinational enterprises (MNEs) on exchange rate pass-through in an environment where an MNE engages in Cournot (quantity) competition with domestic and foreign rivals. The MNE differs from its competitors because it has a lower marginal cost as a result of increased efficiency, and economies of scope as a result of operating in two markets. An MNE can also choose to locate its production for the foreign market domestically (in the location of the MNE's parent), or in the foreign country (the location of the subsidiary). When it locates all its production domestically, it engages in intrafirm trade (IT) in final goods. Otherwise, it is said to engage in international production (IP). Consistent with other studies on exchange rate pass-through under imperfect competition, the authors' analysis shows that exchange rate pass-through into domestic and foreign prices is incomplete. Moreover, the presence of an MNE increases the sensitivity of domestic market prices, and reduces the sensitivity of foreign market prices, to exchange rate movements, relative to arm's-length trade. Furthermore, IT domestic and foreign prices are more sensitive to exchange rate movements than their IP counterparts, and react in the opposite direction. The authors' results indicate that it is important to distinguish between the domestic and the foreign market when looking at the sensitivity of prices and their direction of change. This could potentially explain why some empirical studies find IT prices more sensitive to exchange rate movements and others find them less sensitive.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 06-30.

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Length: 37 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:bca:bocawp:06-30

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Keywords: Economic models; Exchange rates; Market structure and pricing;

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References

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  1. Subramanian Rangan & Robert Z. Lawrence, 1999. "Search and Deliberation in International Exchange: Learning from Multinational Trade About Lags, Distance Effects, and Home Bias," NBER Working Papers 7012, National Bureau of Economic Research, Inc.
  2. Andrew Bernard & Joachim Wagner, 1997. "Exports and success in German manufacturing," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 133(1), pages 134-157, March.
  3. Aw, B. -Y. & Hwang, A. R., 1995. "Productivity and the export market: A firm-level analysis," Journal of Development Economics, Elsevier, vol. 47(2), pages 313-332, August.
  4. Mihir C. Desai & C. Fritz Foley & James R. Hines Jr., 2005. "Foreign Direct Investment and the Domestic Capital Stock," NBER Working Papers 11075, National Bureau of Economic Research, Inc.
  5. Bond, Eric W. & Gresik, Thomas A., 1996. "Regulation of multinational firms with two active governments: A common agency approach," Journal of Public Economics, Elsevier, vol. 59(1), pages 33-53, January.
  6. Dasgupta, Sudipto & Sengupta, Kunal, 1995. "Optimal regulation of MNEs and government revenues," Journal of Public Economics, Elsevier, vol. 58(2), pages 215-234, October.
  7. Giacomo Calzolari, 2004. "Incentive Regulation of Multinational Enterprises," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(1), pages 257-282, 02.
  8. Markusen, James R., 1984. "Multinationals, multi-plant economies, and the gains from trade," Journal of International Economics, Elsevier, vol. 16(3-4), pages 205-226, May.
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