Exchange-Rate Regimes and the Behaviour of Exporters

This paper proposes a firm-level mechanism that explains why exchange-rate regimes are largely neutral with respect to real macro variables: exporters actively adjust marginal costs and markups to absorb nominal exchange-rate fluctuations. We quantify this mechanism using micro-level data from the European car market (1970–99). We show that floating regimes are associated with limited adjustment in destination-currency prices and limited response in quantities sold. We then estimate a structural demand-and-supply system to recover product-level markups and marginal costs. At breaks from pegged to floating regimes, producer-currency markups (marginal costs) fall on impact by around 11% (10%). A two-country real business cycle model with segmented financial markets, incorporating pricing-to-market and operational hedging, rationalises these patterns. Our model underscores the role of real micro rigidities, rather than nominal rigidities, in the weak transmission of exchange-rate fluctuations to real macro variables.