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Exchange rate pass-through in a competitive model of pricing-to-market

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  • Raphael Auer
  • Thomas Chaney

Abstract

This paper extends the Mussa and Rosen (1978) model of quality-pricing under perfect competition. Exporters sell goods of different qualities to consumers who have heterogeneous preferences for quality. Production is subject to decreasing returns to scale and, therefore, supply and the toughness of competition react to cost changes brought about by exchange rate fluctuations. First, we predict that exchange rate shocks are imperfectly passed through into prices. Second, prices of low quality goods are more sensitive to exchange rate shocks than prices of high quality goods. Third, in response to an exchange rate appreciation, the composition of exports shifts towards higher quality and more expensive goods.> ; We test these predictions using highly disaggregated price and quantity U.S. import data. We find evidence that in response to an exchange rate appreciation, the composition of exports shifts towards high unit price goods. Therefore, exchange rate passthrough rates that are measured using aggregate data will tend to overstate the actual extent of pass-through.

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Paper provided by Federal Reserve Bank of Dallas in its series Globalization and Monetary Policy Institute Working Paper with number 23.

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Date of creation: 2009
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Handle: RePEc:fip:feddgw:23

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Keywords: Foreign exchange rates ; Econometric models ; International trade;

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  2. Gagnon, Joseph E. & Knetter, Michael M., 1995. "Markup adjustment and exchange rate fluctuations: evidence from panel data on automobile exports," Journal of International Money and Finance, Elsevier, vol. 14(2), pages 289-310, April.
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  21. Hellerstein, Rebecca, 2008. "Who bears the cost of a change in the exchange rate? Pass-through accounting for the case of beer," Journal of International Economics, Elsevier, vol. 76(1), pages 14-32, September.
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