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Market Power, Innovative Activity and Exchange Rate Pass-Through

  • Sophocles N. Brissimis


    (Bank of Greece, Economic Research Department and University of Piraeus)

  • Theodora S. Kosma

    (Bank of Greece, Economic Research Department)

This paper considers an international oligopoly where firms simultaneously choose both the amount of output produced and the proportion of R&D investment to output. The model captures the links between the exchange rate, market power, innovative activity and price, which are important for the determination of the optimal degree of exchange rate pass-through. It is found that in the long run the pass-through elasticity can be less than, equal to or greater than one depending on R&D effectiveness but in any case it is higher than in models that do not endogenise innovation decisions. The empirical implications of the model are tested using data for Japanese firms exporting to the US market and applying the Johansen multivariate cointegration technique. Particular attention is given to the estimation and identification of the equilibrium price and R&D-intensity equations. The empirical results indicate that price-setting and R&D-intensity decisions of firms are jointly determined in the long run. This interdependence must be taken into account if an accurate estimate of the exchange rate pass-through is to be obtained.

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Paper provided by Bank of Greece in its series Working Papers with number 22.

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Length: 32 pages
Date of creation: Apr 2005
Date of revision:
Handle: RePEc:bog:wpaper:22
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