Global value chains and exchange rate pass-through—The role of non-linearities

This paper examines the role of global value chains development in reducing the exchange rate pass-through (ERPT) to import and producer prices. In contrast to the existing research, we assume that the decline in ERPT resulting from the enhanced participation in GVC may be non-linear with respect to country’s position in the global value chain due to different firms’ market power at various stages of vertical specialization. We investigate a panel of 43 advanced and emerging market economies using a panel smooth transition regression model and WIOD data. We find that growing backward GVC participation of the suppliers of imported intermediate input results in a reduction of the ERPT to producer prices in the importing country. Moreover this effect is non-linear. The ERPT for countries whose suppliers are strongly involved in the production along the global value chains is significantly (four times) smaller than for economies with suppliers not participating in GVC. We also document that the decline in aggregate ERPT in recent years resulted mainly from changes occurring in ERPT for the EU member states due to increased backward GVC participation of their major trading partners, while the ERPT for other countries has in fact remained roughly unchanged throughout the analyzed period.