Exchange Rate Pass-Through and Credit Constraints: Firms Price to Market as Long as They Can
AbstractThe macroeconomic evidence on the short-term impact of exchange rates on exports and prices is notoriously weak. In this paper I examine the micro-foundations of this disconnect by looking at firms' export and price setting decisions in response to fluctuations in exchange rates and credit conditions using German firm survey data. Firm- level data on pricing and export expectations enables me to measure the instantaneous response of each firm to changing financial constraints and the EUR/USD exchange rate, which avoids endogeneity issues. I find that primarily large firms cause the exchange rate "puzzles" in aggregate data. The exchange rate disconnect disappears for financially constrained firms. For these firms, the pass-through rate of exchange rate changes to prices is more than twice the rate of unconstrained firms. Similarly, their export volumes are about twice as sensitive to exchange rate fluctuations. Credit therefore affects not only exports via trade finance, but also international relative prices by constraining the scope of feasible pricing policies. The effect of borrowing constraints is particularly strong during the recent financial crisis.
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Bibliographic InfoPaper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 788.
Date of creation: 21 Oct 2011
Date of revision: 13 Feb 2012
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More information through EDIRC
exchange rate pass-through; exchange rate disconnect; financing constraints; pricing to market; exports; credit crunch; trade collapse; law of one price; trade finance;
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-10-22 (All new papers)
- NEP-CBA-2011-10-22 (Central Banking)
- NEP-CIS-2011-10-22 (Confederation of Independent States)
- NEP-HME-2011-10-22 (Heterodox Microeconomics)
- NEP-IFN-2011-10-22 (International Finance)
- NEP-INT-2011-10-22 (International Trade)
- NEP-MON-2011-10-22 (Monetary Economics)
- NEP-OPM-2011-10-22 (Open Economy Macroeconomic)
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