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State Dependent Pricing and Exchange Rate Pass-Through

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  • Flodén, Martin

    ()
    (Department of Economics, Stockholm School of Economics)

  • Wilander, Fredrik

    ()
    (Department of Economics, Stockholm School of Economics)

Abstract

We analyze exchange rate pass-through and volatility of import prices in a dynamic framework where firms are subject to menu costs and decide on price adjustments in response to exchange rate innovations. The exchange rate pass-through and import price volatility then depend on the pricing convention in combination with functional forms of cost and demand functions. In particular, there is lower pass-through, less frequent price adjustments, lower price volatility, and slightly lower average prices when prices are set in the importer’s currency than when prices are set in the exporter’s currency. The degree of pass-through also depends on the magnitude of exchange rate innovations. Large exchange rate innovations raise pass-through if prices are set in the importer’s currency but reduce pass-through if prices are set in the exporter’s currency. Finally, the presence of inflation can generate a substantial asymmetry in price adjustments. This asymmetry could lead to pitfalls when empirically estimating pass-through, and we present some potential resolutions to this estimation problem.

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Bibliographic Info

Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 174.

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Length: 30 pages
Date of creation: 01 Dec 2004
Date of revision:
Publication status: Forthcoming in Journal of International Economics.
Handle: RePEc:hhs:rbnkwp:0174

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Keywords: Exchange rate pass-through; Nominal rigidities; Invoicing; State dependent pricing;

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References

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  1. Michael Devereux & Charles Engel & Cedric Tille, 1999. "Exchange-Rate Pass-Through and the Welfare Effects of the Euro," Discussion Papers in Economics at the University of Washington 0034, Department of Economics at the University of Washington.
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Cited by:
  1. Nakamura, Emi & Zerom, Dawit, 2008. "Accounting for Incomplete Pass-Through," MPRA Paper 14389, University Library of Munich, Germany.

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