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A Regime Switching Analysis of Exchange Rate Pass-through

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Author Info
Kólver Hernández () (Department of Economics,University of Delaware and CIDE)
Asli Leblebicioglu () (North Carolina State University)

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Abstract

We investigate changes in the pricing policies of exporters, including changes in the exchange rate pass-through elasticity, and changes in the elasticities of variables that affect the firm’s markup. We set up a theoretical model of optimal export pricing in order to illustrate how changes in the pass-through elasticity can emerge together with changes in other elasticities in the pricing policy. Based on our theoretical formulation, we empirically study changes in all the elasticities that define the pricing policy as opposed to focusing only on the exchange rate pass-through. In the empirical model, we assume that in every period exporters get to set prices by following either a “high pass-through” or a “low passthrough” pricing policy. The transition from one policy to the other is governed by a Markov process whose transition probabilities depend on economic fundamentals. We estimate the model using data we have collected on 35 lines of imported cars to the US, from seven exporting countries, for the 1980-2004 period. We find that the “low pass-through” regime is characterized by: a low exchange rate pass-through; a low response to misalignments in the firm’s relative price; a low volatility of technology and preference shocks; and a higher duration than the high pass-through regime. Monetary stability and the market structure are significant factors behind the switching of pricing policies. Ceteris paribus, monetary stability measured as the cross-country inflation differential explains abut 22% of the year-to-year variation in the exchange rate pass-through coefficient; when measured by the volatility of the exchange rate, it explains 37%. Market concentration measured by the Herfindahl index explains about 40%.

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Paper provided by University of Delaware, Department of Economics in its series Working Papers with number 08-17.

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Length: 40 pages
Date of creation: 2008
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Handle: RePEc:dlw:wpaper:08-17.

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Related research
Keywords: Exchange Rate Pass-through; Markov Regime Switching; Export Pricing;

Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
F31 - International Economics - - International Finance - - - Foreign Exchange
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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