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Why Do Consumer Prices React Less Than Import Prices to Exchange Rates?

Listed author(s):
  • Philippe Bacchetta

    (Study Center Gerzensee, University of Lausanne, Center for Economic Policy Research,)

  • Eric van Wincoop

    (University of Virginia, National Bureau of Economic Research,)

It is well known that the extent of pass-through of exchange rate changes to consumer prices is much lower than to import prices. One explanation is local distribution costs. Here we consider an alternative, complementary explanation based on the optimal pricing strategies of firms. We consider a model where foreign exporting firms sell intermediate goods to domestic firms. Domestic firms assemble the imported intermediate goods and sell final goods to consumers. When domestic firms face significant competition from other domestic final goods producing sectors (e.g., the nontraded goods sector) we show that they prefer to price in domestic currency, while exporting firms tend to price in the exporter's currency. In that case the pass-through to import prices is complete, while the pass-through to consumer prices is zero. (JEL: F31, F41) Copyright (c) 2003 The European Economic Association.

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Article provided by MIT Press in its journal Journal of the European Economic Association.

Volume (Year): 1 (2003)
Issue (Month): 2-3 (04/05)
Pages: 662-670

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Handle: RePEc:tpr:jeurec:v:1:y:2003:i:2-3:p:662-670
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  1. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers.
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  10. Devereux, Michael B & Engel, Charles M & Storgaard, Peter Ejler, 2002. "Endogenous Exchange Rate Pass-Through When Nominal Prices Are Set in Advance," CEPR Discussion Papers 3608, C.E.P.R. Discussion Papers.
  11. Eric van Wincoop & Philippe Bacchetta, 2000. "Does Exchange-Rate Stability Increase Trade and Welfare?," American Economic Review, American Economic Association, vol. 90(5), pages 1093-1109, December.
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