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Price Setting and Exhange Rate Pass-Through


  • Michael B. Devereux

    (University of British Columbia

  • James Yetman

    (University of Hong Kong)


There has been a considerable recent debate on the causes of low pass-through from exchange rates to consumer prices. This paper develops a simple model of a small open economy in which exchange rate pass-through is determined by the frequency of price changes of importing firms. But this, in turn,is determined by the monetary policy rule of the central bank. ¡¥Looser¡¦ monetary policy, which implies a higher mean inflation rate, and a higher volatility of the exchange rate, will lead to more frequent price changes and a higher rate of pass-through. The model implies that there should be a positive, but nonlinear, relationship between pass-through and mean inflation, and a positive relationship between passthrough and exchange rate volatility. In a sample of 122 countries, this is strongly supported by the data. Our conclusion is that, at least partly, low exchange rate pass-through is a result of short-term price rigidities.

Suggested Citation

  • Michael B. Devereux & James Yetman, 2002. "Price Setting and Exhange Rate Pass-Through," Working Papers 222002, Hong Kong Institute for Monetary Research.
  • Handle: RePEc:hkm:wpaper:222002

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    References listed on IDEAS

    1. Corsetti, Giancarlo & Dedola, Luca, 2005. "A macroeconomic model of international price discrimination," Journal of International Economics, Elsevier, vol. 67(1), pages 129-155, September.
    2. Jose Manuel Campa & Linda S. Goldberg, 2002. "Exchange Rate Pass-Through into Import Prices: A Macro or Micro Phenomenon?," NBER Working Papers 8934, National Bureau of Economic Research, Inc.
    3. Devereux, Michael B & Yetman, James, 2003. " Predetermined Prices and the Persistent Effects of Money on Output," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(5), pages 729-741, October.
    4. Taylor, John B., 2000. "Low inflation, pass-through, and the pricing power of firms," European Economic Review, Elsevier, vol. 44(7), pages 1389-1408, June.
    5. Caroline M. Betts & Timothy J. Kehoe, 2008. "Real exchange rate movements and the relative price of non-traded goods," Staff Report 415, Federal Reserve Bank of Minneapolis.
    6. Burstein, Ariel T. & Neves, Joao C. & Rebelo, Sergio, 2003. "Distribution costs and real exchange rate dynamics during exchange-rate-based stabilizations," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1189-1214, September.
    7. Monacelli, Tommaso, 2001. "New International Monetary Arrangements and the Exchange Rate," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 6(4), pages 389-400, October.
    8. Choudhri, Ehsan U. & Hakura, Dalia S., 2006. "Exchange rate pass-through to domestic prices: Does the inflationary environment matter?," Journal of International Money and Finance, Elsevier, vol. 25(4), pages 614-639, June.
    9. Giancarlo Corsetti & Luca Dedola, 2002. "Macroeconomics of international price discrimination," International Finance Discussion Papers 744, Board of Governors of the Federal Reserve System (U.S.).
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