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Exchange Rate Pass-Through and Credit Constraints: Firms Price to Market as Long as They Can

  • Georg H. Strasser

    ()

    (Department of Economics, Boston College)

The macroeconomic evidence on the short-term impact of exchange rates on exports and prices is notoriously weak. In this paper I examine the micro-foundations of this disconnect by looking at firms' export and price setting decisions in response to fluctuations in exchange rates and credit conditions using German firm survey data. Firm- level data on pricing and export expectations enables me to measure the instantaneous response of each firm to changing financial constraints and the EUR/USD exchange rate, which avoids endogeneity issues. I find that primarily large firms cause the exchange rate "puzzles" in aggregate data. The exchange rate disconnect disappears for financially constrained firms. For these firms, the pass-through rate of exchange rate changes to prices is more than twice the rate of unconstrained firms. Similarly, their export volumes are about twice as sensitive to exchange rate fluctuations. Credit therefore affects not only exports via trade finance, but also international relative prices by constraining the scope of feasible pricing policies. The effect of borrowing constraints is particularly strong during the recent financial crisis.

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Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 788.

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Date of creation: 21 Oct 2011
Date of revision: 13 Feb 2012
Publication status: published, Journal of Monetary Economics, 2013, 60:1, 25-38
Handle: RePEc:boc:bocoec:788
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