EXCHANGE RATE PASS-THROUGH INTO IMPORT PRICES Paper by: José Manuel Campa Linda S. Goldberg Presentation by:Fanta Nicolas Mohylová Aneta Polena Michal Veselý Vladimír

Outline Introduction Methodology Results Conclusion

Basic terms  Exchange rate pass-through  Measure of how responsive international prices are to changes in the exchange rate  Complete vs. zero exchange rate pass-through  PCP – producer-currency pricing  Prices preset by exporters  Complete pass-through  The law of one price holds  LCP – local-currency pricing  Firms preset prices on the export markets  Zero pass-through  The law of one price violated whenever exchange rate fluctuates unexpectedly

Motivation  Long been of various interest  Recently central role in heated debates over appropriate monetary policies and exchange rate regime optimality  The evidence of exchange rate pass-through for 23 OECD countries  What explains the difference in pass-through rates across different countries?  The stability of exchange pass-through rates – Brazilian experience extended to the OECD countries?  The drivers of the changes in pass-through rates  Aggregated vs. disaggregated import prices

Outline Introduction Methodology Results Conclusion

Methodology

Data  23 OECD countries  Quarterly data  1975 – 2003  Nominal and real exchange rates  GDP  Export partner cost proxy  Import prices indices  Aggregated  Disaggregated  Food  Manufacturing  Energy  Raw materials  Nonmanufactured products

Outline Introduction Methodology Results Conclusion

Results

LLP versus PCP  LLP = local currency pricing  PCP = producer currency pricing  LCP represents a null hypothesis of zero pass-through whereas PCP implies a pass-through of unity  LCP can be rejected for 20 of the 23 countries in the short run and 18 of 23 in the long run  PCP can also be rejected in the short run 22 out of the 23 countries and 7 of 23 in the long run

Differences in Aggregate Pass-through  The hypothesis of a same pass-through elasticity across countries was rejected at a 1% level  What are the causes of the differences in elasticities?  Stability of local monetary policy (Devereux and Engel (2001))  If the exporters choose PCP and their country have a stable monetary policy ⇒ their export prices should be more stable  All else equal, exchange rate pass-through should be higher for countries with more volatile monetary policy  Exchange rate variability and local monetary volatility could also enter through exporter competition for market share (Froot and Klemperer (1989))  Exchange rate pass-through may be lower when nominal exchange rate variability is high and exporters to a country try to maintain local market share  Countries can have different sector-specific openness  The pass-trough elasticity for raw materials can be higher than for food

Differences in Aggregate Pass-through

Stability of Aggr. Pass-through Elasticities  There is a mix of increases and decreases in exchange rate pass-through elasticities across countries  SR and LR exchange rate pass-through elasticities declined for 15 of the 21 countries, and increased for the other 6 countries (only 3 cases significant)  There is also evidence supporting structural breaks in pass-through  short-run pass-through stability is rejected for 7 countries  We can never reject stability of long-run pass-through according to these tests

Exchange Rate Pass-through into Disaggregated Import Prices  The OECD assembles data on disaggregated import prices at the country level for the five product categories

Exchange Rate Pass-through into Disaggregated Import Prices cont'd…  The authors reject the hypothesis of zero exchange rate pass-through (LCP) for each product category except energy  They similarly reject complete pass-through (PCP) for manufacturing and food  Manufacturing imports has the strongest evidence support of partial pass- through (19 out of 22 countries). Food shows partial pass-through in the short as well

Different pass-through elasticities across industries  Manufacturing imports was taken as a base and compared to other industries (M. average pass-through elasticity = 0.43)  Food was not statistically different (F. average pass-through elasticity = 0.46)  Most extreme case were energy product with 9 out of 22 countries with statistically different coefficients (E. average pass-through elasticity = 0.75)

The Evolution in Import Composition  Manufacturing imports were typically less that 50% of the overall import for most countries in 1980  By 1992, 65% of imports in the OECD countries were manufactured products  70% was the average share of manufactured imports in total imports for the OECD in 2002

Understanding the Evolution of Aggregate Pass-through  The effect of the import composition and macroeconomic conditions on markups can change the aggregate import-price pass-through  However, approximately only 30% of the observed differences over time in the short-run pass-through elasticities of countries are explained by macro variablesimputed trade shares and time dummies  The key explanatory determinant for sensitivity of import prices to exchange rates in the short-run and long-run is import trade composition

Outline Introduction Methodology Results Conclusion

 46% of exchange rate fluctuations in the short run, and nearly 65% over the long run is reflected in import prices in local currencies  Partial pass-through elasticities are the best explenation of import price in the short run. In the long run there is more evidence for producer currency pricing  Even though macroeconomic variables are significant in the model, they have a small effect on the development of pass-through elasticities over time. Composition of import bundles have proved to be more important in explaining pass-through changes across OECD countries

Thank you for your attention

References *  CAMPA, Jose a Linda S GOLDBERG. Exchange rate pass-through into import prices. Harvard College and the Massachusetts Institute of Technology, [2005]. The Review of Economics and Statistics. *All tables, graphs and data in this presentation are taken from the above mentioned reference.