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Deep habits and exchange rate pass-through

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  • Jacob, Punnoose
  • Uusküla, Lenno

Abstract

Habit persistence at the level of individual goods varieties can explain incomplete exchange rate pass-through to international prices. Deep habits give rise to a dynamic import demand function that leads to import price markup adjustments, independently of nominal pricing frictions. Augmenting a two-country DSGE model with deep habits, we obtain low exchange rate pass-through to import prices even when nominal local currency price rigidities are negligibly low. As nominal pricing frictions become more important, the presence of deep habits further impedes the pass-through of exchange rate fluctuations. Estimating model variants with limited information as well as full information methods, we find that the deep habits model requires much lower degrees of nominal price rigidities to match empirical measures of the pass-through of exchange rate fluctuations to US import prices.

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  • Jacob, Punnoose & Uusküla, Lenno, 2019. "Deep habits and exchange rate pass-through," Journal of Economic Dynamics and Control, Elsevier, vol. 105(C), pages 67-89.
  • Handle: RePEc:eee:dyncon:v:105:y:2019:i:c:p:67-89
    DOI: 10.1016/j.jedc.2019.05.011
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    Cited by:

    1. Choi, Yoonho & Choi, E. Kwan, 2018. "Unemployment and optimal exchange rate in an open economy," Economic Modelling, Elsevier, vol. 69(C), pages 82-90.
    2. Dudley Cooke, 2019. "Consumer Search, Incomplete Exchange Rate Pass‐Through, and Optimal Interest Rate Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 51(2-3), pages 455-484, March.
    3. Jacob, Punnoose & Uusküla, Lenno, 2019. "Deep habits and exchange rate pass-through," Journal of Economic Dynamics and Control, Elsevier, vol. 105(C), pages 67-89.

    More about this item

    Keywords

    Exchange rate pass-through; Deep habits; Customer markets; Local currency pricing; Impulse response matching; Bayesian estimation;

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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