Heterogeneous exchange rate pass-through in Mexico: What drives it?

In this paper, we focus on the pass-through of exchange rate fluctuations into prices of final goods and services and examine whether contrasting pass-through rates are associated with regional and/or product-specific characteristics. Using CPI micro-data from 2002 to 2010, we estimate industry-specific rates of pass-through across regions in Mexico. By looking at within-country price responses, we alleviate shortcomings of cross-country studies that assess pass-through determinants. The results indicate that pass-through rates differ across regions and industries: low pass-through regions exhibit nearly one-quarter of the elasticity shown by high pass-through regions after twelve months. This heterogeneity prevails at longer horizons. The findings suggest that full pass-through is rejected for all regions and industries. Most of these differences in transmission rates are explained by regional and product characteristics: demand conditions, economic development, distance to the US border, import intensity, price change dispersion and expenditure share play a clear role in increasing pass-through, whereas market density dampens pass-through rates. The evidence confirms pricing-to-market theories and has implications for the design of monetary and exchange rate policies.