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Why Do Consumer Prices React less than Import Prices to Exchange Rates?

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Listed:
  • Philippe Bacchetta

    (University of Lausanne, Studienzentrum Gerzensee and CEPR)

  • Eric van Wincoop

    (University of Virginia)

Abstract

It is well known that the extent of pass-through of exchange rate changes to consumer prices is much lower than to import prices. One explanation is local distribution costs. Here we consider an alternative, complementary, explanation based on the optimal pricing strategies of firms. We consider a model where foreign exporting firms sell intermediate goods to domestic firms. Domestic firms assemble the imported intermediate goods and sell final goods to consumers. When domestic firms face significant competition from other domestic final goods producing sectors (e.g., the non-traded goods sector) we show that they prefer to price in domestic currency, while exporting firms tend to price in the exporter's currency. In that case the pass-through to import prices is complete, while the pass-through to consumer prices is zero.

Suggested Citation

  • Philippe Bacchetta & Eric van Wincoop, 2002. "Why Do Consumer Prices React less than Import Prices to Exchange Rates?," Working Papers 02.05, Swiss National Bank, Study Center Gerzensee.
  • Handle: RePEc:szg:worpap:0205
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    References listed on IDEAS

    as
    1. Burstein, Ariel Tomas & Eichenbaum, Martin & Rebelo, Sérgio, 2002. "Why Are Rates of Inflation So Low After large Devaluations," CEPR Discussion Papers 3178, C.E.P.R. Discussion Papers.
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    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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