The exchange rate: what's in it for prices?

Large movements in the exchange rate are quite common, and they substantially alter one's purchasing power when traveling abroad. Yet these exchange rate movements tend to have a smaller impact on the price of foreign goods that are imported. Following an appreciation of the euro against the dollar, European firms selling products to American firms for import do not raise their prices by nearly as much as the prices they charge consumers in the European market. Similarly, American firms sell their products at higher prices in Europe than at home. This incomplete, or partial, pass-through of exchange rate movements to domestic import prices is important for inflation, American purchasing power, and the pattern of trade between countries. In this article, George Alessandria and Jarcy Zee discuss some of the reasons why changes in the exchange rate may not be fully passed through to import prices.