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Exchange Rate Pass-Through: A Competitive Search Approach

Author

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  • Beverly Lapham

    ()

  • Ayman Mnasri

    () (Qatar University)

Abstract

We develop an open economy monetary model with heterogeneous households which is characterized by incomplete pass-through of exchange rate movements to import prices. Partial pass-through arises in our environment due to the presence of competitive search in international goods' markets. Under competitive search, agents choose a sub-market in which to exchange goods, where different sub-markets are characterized by different price and trading probability combinations. Preference and policy shocks which induce exchange rate movements cause households to choose a different sub-market for their purchases of traded goods--an extensive margin response. These responses mitigate the direct effect of nominal exchange rate changes on equilibrium traded goods' prices, thereby generating incomplete exchange rate pass-through to goods' prices. In the calibrated model, exchange rate pass-through due to foreign shocks ranges between 19% and 62%, which is in the range of import price pass-through estimates for developed economies. Due to risk aversion by households, the magnitude of pass-through depends on the size and direction of the initial shock, making the model consistent with the observed phenomenon of asymmetric pass-through. Importantly, by incorporating household heterogeneity, we are able to examine the role of precautionary savings in affecting pass-through, characterize how pass-through varies across different types of households, and examine the distributional effects of exchange rate movements.

Suggested Citation

  • Beverly Lapham & Ayman Mnasri, 2019. "Exchange Rate Pass-Through: A Competitive Search Approach," Working Paper 1418, Economics Department, Queen's University.
  • Handle: RePEc:qed:wpaper:1418
    as

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    File URL: https://www.econ.queensu.ca/sites/econ.queensu.ca/files/wpaper/qed_wp_1418.pdf
    File Function: First version 2019
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    References listed on IDEAS

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    1. repec:bla:jorssa:v:180:y:2017:i:2:p:587-612 is not listed on IDEAS
    2. Delatte, Anne-Laure & López-Villavicencio, Antonia, 2012. "Asymmetric exchange rate pass-through: Evidence from major countries," Journal of Macroeconomics, Elsevier, vol. 34(3), pages 833-844.
    3. Menzio, Guido & Shi, Shouyong & Sun, Hongfei, 2013. "A monetary theory with non-degenerate distributions," Journal of Economic Theory, Elsevier, vol. 148(6), pages 2266-2312.
    4. Paul R. Bergin & Robert C. Feenstra, 2017. "Pricing-to-Market, Staggered Contracts, and Real Exchange Rate Persistence," World Scientific Book Chapters,in: International Macroeconomic Interdependence, chapter 6, pages 155-185 World Scientific Publishing Co. Pte. Ltd..
    5. Webber, Anthony G., 2000. "Newton's gravity law and import prices in the Asia Pacific," Japan and the World Economy, Elsevier, vol. 12(1), pages 71-87, January.
    6. Raphael Brun-Aguerre & Ana-Maria Fuertes & Matthew Greenwood-Nimmo, 2017. "Heads I win; tails you lose: asymmetry in exchange rate pass-through into import prices," Journal of the Royal Statistical Society Series A, Royal Statistical Society, vol. 180(2), pages 587-612, February.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Exchange Rate Pass-Through: A Competitive Search Approach
      by Christian Zimmermann in NEP-DGE blog on 2019-09-22 22:01:28

    More about this item

    Keywords

    Exchange Rate Pass-Through; Competitive Search; Monetary Policy;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • O24 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Trade Policy; Factor Movement; Foreign Exchange Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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