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

  • 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. Michael B. Devereux & Charles Engel & Peter E. Storgaard, 2002. "Endogenous Exchange Rate Pass-Through When Nominal Prices are Set in Advance," Working Papers 212002, Hong Kong Institute for Monetary Research.
  2. Jose Manuel Campa & Linda S. Goldberg, 2002. "Exchange rate pass-through into import prices: a macro or micro phenomenon?," Staff Reports 149, Federal Reserve Bank of New York.
  3. McCallum, B.T. & Nelson, E., 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Papers 644, Stockholm - International Economic Studies.
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  5. Philippe BACCHETTA & Eric VAN WINCOOP, 1999. "Does Exchange Rate Stability Increase Trade and Welfare ?," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 9917, Université de Lausanne, Faculté des HEC, DEEP.
  6. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers.
  7. Corsetti, Giancarlo & Dedola, Luca, 2005. "A macroeconomic model of international price discrimination," Journal of International Economics, Elsevier, vol. 67(1), pages 129-155, September.
  8. Ariel Burstein & Martin Eichenbaum & Sergio T. Rebelo, 2002. "Why Are Rates of Inflation So Low After Large Devaluations?," RCER Working Papers 486, University of Rochester - Center for Economic Research (RCER).
  9. Giancarlo Corsetti & Paolo Pesenti, 2001. "International Dimensions of Optimal Monetary Policy," NBER Working Papers 8230, National Bureau of Economic Research, Inc.
  10. Giancarlo Corsetti & Luca Dedola, 2002. "Macroeconomics of international price discrimination," Temi di discussione (Economic working papers) 461, Bank of Italy, Economic Research and International Relations Area.
  11. Pinelopi Koujianou Goldberg & Michael M. Knetter, 1997. "Goods Prices and Exchange Rates: What Have We Learned?," Journal of Economic Literature, American Economic Association, vol. 35(3), pages 1243-1272, September.
  12. Betts, Caroline & Devereux, Michael B., 1996. "The exchange rate in a model of pricing-to-market," European Economic Review, Elsevier, vol. 40(3-5), pages 1007-1021, April.
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