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Domestic wedges and the (in)sensitivity of CPI to exchange rates

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  • Errico, Marco

Abstract

Earlier literature highlights domestic wedges — distribution costs, variable markups, and nominal rigidities — in limiting exchange rate pass-through to consumer prices. Using granular Chilean data, I quantify their impact, considering input–output linkages and sectoral heterogeneity. Domestic wedges reduce CPI sensitivity to exchange rate fluctuations by 57%. Distribution costs account for 48% of the overall reduction in sensitivity, variable markups for 29%, and nominal rigidities for 23%. These factors dampen CPI sensitivity more than incomplete pass-through into prices at the border. Eliminating sectoral heterogeneity in wedges increases CPI response by 55%, as import exposure positively correlates with wedge strength. Ignoring this heterogeneity misidentifies key sectors driving exchange rate effects on consumer prices. Contrary to earlier quantification strategies, I show that CPI sensitivity mainly stems from imported consumption goods, as domestic wedges weaken the amplification role of input–output linkages.

Suggested Citation

  • Errico, Marco, 2026. "Domestic wedges and the (in)sensitivity of CPI to exchange rates," Journal of International Economics, Elsevier, vol. 161(C).
    • Handle: RePEc:eee:inecon:v:161:y:2026:i:c:s0022199626000279
    DOI: 10.1016/j.jinteco.2026.104237
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    JEL classification:

    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • D57 - Microeconomics - - General Equilibrium and Disequilibrium - - - Input-Output Tables and Analysis
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General

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