Global value chains and exchange rate pass-through: the role of non-linearities

We examine the relationship between development of global value chains and changes in the exchange rate pass-through to producer prices. In contrast to the existing research we assume that the decline in ERPT resulting from the enhanced participation in GVC may be nonlinear with respect to the country’s position in the global value chain, reflecting divergent firms’ market power at various stages of vertical specialization process. We investigate a panel of 43 advanced and emerging economies using a panel smooth transition regression (PSTR) model and WIOD data and find that growing backward GVC participation of the suppliers of imported intermediate input results in the reduction of the ERPT to producer prices. We also provide evidence that this effect is non-linear. The exchange rate pass-through for countries, whose suppliers are strongly involved in the production along the global value chains is significantly (four times) smaller than for economies with suppliers not participating in GVC. We document that the decline in the aggregate ERPT in recent years has been mainly due to changes in the exchange rate pass-through for the EU members states due to increased backward GVC participation of their major trading partners. For other countries, the ERPT remained roughly the same throughout the analyzed period.