State Dependent Pricing and Exchange Rate Pass-Through

Martin Flodén and Fredrik Wilander ()
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Fredrik Wilander: Department of Economics, Stockholm School of Economics, Postal: Box 6501, SE-113 83 Stockholm, Sweden

No 174, Working Paper Series from Sveriges Riksbank (Central Bank of Sweden)

Abstract: We analyze exchange rate pass-through and volatility of import prices in a dynamic framework where firms are subject to menu costs and decide on price adjustments in response to exchange rate innovations. The exchange rate pass-through and import price volatility then depend on the pricing convention in combination with functional forms of cost and demand functions. In particular, there is lower pass-through, less frequent price adjustments, lower price volatility, and slightly lower average prices when prices are set in the importer’s currency than when prices are set in the exporter’s currency. The degree of pass-through also depends on the magnitude of exchange rate innovations. Large exchange rate innovations raise pass-through if prices are set in the importer’s currency but reduce pass-through if prices are set in the exporter’s currency. Finally, the presence of inflation can generate a substantial asymmetry in price adjustments. This asymmetry could lead to pitfalls when empirically estimating pass-through, and we present some potential resolutions to this estimation problem.

Keywords: Exchange rate pass-through; Nominal rigidities; Invoicing; State dependent pricing (search for similar items in EconPapers)
JEL-codes: D40 E30 F31 F40 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2004-12-01
New Economics Papers: this item is included in nep-ifn and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Forthcoming in Journal of International Economics.

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Persistent link: https://EconPapers.repec.org/RePEc:hhs:rbnkwp:0174

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