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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 toward higher quality and more expensive goods. We test these predictions using highly disaggregated price and quantity U.S. import data and find only weak empirical evidence in support of our theory.
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Suggested Citation

  • Raphael Auer & Thomas Chaney, 2008. "Exchange rate pass-through in a competitive model of pricing-to-market," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgpr:y:2008:x:8
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    File URL: http://www.federalreserve.gov/events/conferences/2007/20070927/program.htm
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    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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