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

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Philippe Bacchetta
Eric van Wincoop

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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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9352.

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Date of creation: Nov 2002
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Handle: RePEc:nbr:nberwo:9352

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F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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