Exchange Rate Pass‐through to Trade Prices: The Role of Nonlinearities and Asymmetries^*

Abstract

A standard assumption in the empirical literature is that exchange rate pass‐through is both linear and symmetric. This study tests these assumptions for export and import prices in the G7 economies. It focuses on non‐linearities in the reaction of profit margins to exchange rate movements, which may arise from the presence of price rigidities and switching costs. Nonlinearities are characterized by augmenting a standard linear model with polynomial functions of the exchange rate and with interactive dummy variables. The results suggest that nonlinearities and especially asymmetries cannot be ignored, although their magnitude varies noticeably across countries.

Recent estimates of exchange rate pass-through to import prices in the euro area

“…21 This puzzling result has already been pointed out throughout the ERPT literature (see e.g. Bussière 2013). Turning to the estimated ERPT coefficients, we observe that ERPT elasticities are positively significant in all EA countries and bounded between 0.28% (for Austria) and 0.59% (for Italy).…”

Import price dynamics in major advanced economies and heterogeneity in exchange rate pass-through

“…While the …ndings reported above do not show any structural break, this does not mean that the import price determination has not been subject to any where changes in import prices depend on changes in exchange rates and in foreign prices 8 .…”

“…Assuming imperfect competition, exporters price their products by taking into account the demand function (8). All …rms share the same cost function C(j), assumed to be homogenous of degree one in output.…”

“…Nevertheless, we do …nd some positive correlation between EE exchange rates and pass-through in the euro area, Japan, Canada and the U.K. In other words, an appreciation in EE exchange rates 1 3 For the role of non-linearities and asymetries in exchange rate pass-through to trade prices, see Bussiere (2007).…”

“…The fact that we cannot reject 8 De Bandt et al (2008) are however sceptical about such speci…cation and rather favour estimations including cointegrating relationships. As we have not been able to …nd any cointegrating relationships among the variables of our sample, we have disregarded such speci…-cations.…”