Prices and Exchange Rates: A Theory of Disconnect

Abstract

I present a sticky-wage model of exchange rate pass-through with heterogeneous producers and endogenous markups. The model shows that low levels of exchange rate pass-through to firm-and aggregate-level import prices coexist with large movements in trade flows. After an exchange rate shock, aggregate import prices are subject to a composition bias due to changes in the extensive margin of trade (the number of goods traded between countries). At the firm level, each producer adjusts its markups depending on its own productivity and the change in the competitive environment generated by the exchange rate movement. Firm-level price responses are asymmetric-different for appreciations and depreciations-and adjustments in the intensive margin of trade (firm-level exports) are substantial. In general equilibrium, the model shows that firm reallocations increase the persistence of exogenous shocks.Keywords: exchange rate pass-through, expenditure-switching effect, heterogeneous firms, endogenous markups. JEL codes: F12, F41. * I am deeply indebted to Maury Obstfeld for his guidance, encouragement, and support. I also thank Luis Catao, Barry Eichengreen, Fabio Ghironi, Ami Glazer, Pierre-Olivier Gourinchas, Rob Johnson, Jaewoo Lee, Priya Ranjan, Guillaume Rocheteau, and seminar participants at many institutions for helpful comments and suggestions. This version of the paper also greatly benefited from the comments and suggestions of Bruno Biais (the editor) and three anonymous referees. I thank Monica Crabtree-Reusser for editorial assistance. Financial support from CONACYT, UC MEXUS, and the Chiles Foundation is gratefully acknowledged. This paper is a substantially revised version of the first chapter of my Ph.D. dissertation at UC Berkeley. All remaining errors are my own.

Multiple-Product Firms and Product Switching

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Quality, Trade, and Exchange Rate Pass-Through

“…8 Basile, de Nardis, and Girardi (2012) develop a model based on Melitz and Ottaviano (2008) and predict that exchange rate pass-through is lower for higher quality goods. By contrast, using a translog expenditure function to generate endogenous markups in a model where …rms are heterogeneous in productivity and product quality, Rodríguez-López (2011) predicts that the response of markups to exchange rate shocks decreases with productivity and quality where quality is inferred from trade unit values. In contrast, using a data set on the prices and numbers of cars traded in Europe, Auer et al (2012) …nd some evidence that pass-through decreases with hedonic quality indices estimated from regressions of car prices on car characteristics such as weight, horse power, and fuel e¢ciency.…”

International trade without CES: Estimating translog gravity

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