The continuing depreciation of the dollar against other major currencies, coupled with concerns about the impact of China's exchange-rate policy on domestic prices, has spurred new interest in the exchange-rate pass-through literature. A recent study by economists at the Board of Governors attracted wide attention by documenting a steady decline over the past decade in the pass-through of exchange rates into U.S. import prices. This finding was later challenged by a study published by the Federal Reserve Bank of New York (see Mario Marazzi et al (2005) versus Rebecca Hellerstein, Deirdre Daly, and Christina Marsh (2006)), which demonstrated that the finding of such a decline depends crucially on the specification of the pass-through regression, and in particular the inclusion of commodity prices. This exchange highlights the need to understand the structural determinants of exchange rate pass-through, not only because such understanding is important when trying to forecast future pass-through patterns, but also because it provides guidance regarding the specification of the appropriate reduced-form regression, and more generally, measurement of pass-through.The increased availability of micro data on prices and quantities means that research uncovering these determinants is more promising than ever. This paper lays out a structural approach that can be used to identify the determinants of incomplete exchange rate pass-through. We argue that despite the use of parametric assumptions, our identification method that relies on exploiting exchange rate variability is general, and can be applied to a variety of markets and data. We show that existing micro studies yield surprisingly robust results regarding the sources of incomplete pass-through, with non-traded local costs emerging as the primary cause, in spite of differences in industries and countries investigated, modelling assumptions and data. We conclude by noting limitations of this approach and suggesting directions for future research.
We thank the editor, Enrique Sentana, and three anonymous referees for valuable comments and suggestions. We are grateful to Charles Engel for very useful conversations at an early stage of this project and have also benefited from the comments of seminar participants
How rigid are producer prices? A long-standing conventional wisdom among economists holds that producer prices are more rigid than and so play less of an allocative role than do consumer prices. In the 1987-2008 micro data collected by the U.S. Bureau of Labor Statistics for the Producer Price Index (PPI), we find that producer prices for finished goods and services in fact exhibit roughly the same degree of flexibility as do consumer prices, with a median frequency of price change that falls between that of consumer prices including, and excluding, sales. This pattern becomes clear once one weights large firms by their revenue in aggregating the data, as large firms change prices two to three times more frequently than do small firms, and by smaller amounts. We also find that longer price durations are associated with larger price changes for goods firms, but not for services firms, and that while long-term contracts are associated with somewhat greater price rigidity for both goods and services firms, the differences are not dramatic. Finally, the size of price decreases plays a key role in PPI inflation dynamics, a fact that is not accounted for by standard workhorse macroeconomic pricing models.
This article appeared in a journal published by Elsevier. The attached copy is furnished to the author for internal non-commercial research and education use, including for instruction at the authors institution and sharing with colleagues.Other uses, including reproduction and distribution, or selling or licensing copies, or posting to personal, institutional or third party websites are prohibited. A large share of international trade occurs through intra-firm transactions. We show that this common crossborder organization of the firm has implications for the well-documented incomplete transmission of shocks across such borders. We present new evidence of an inverse relationship between a firm's outsourcing of inputs and its rate of exchange-rate pass-through. We then develop a structural econometric model with final assemblers and upstream parts suppliers to quantify how firms' organization of their activities across national borders affects their pass-through behavior.
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