The Exchange Rate Pass -Through to Import and Export Prices: The Role of Nominal Rigidities and Currency Choice

IMF Working Papers, September 1, 2012

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Using both regression- and VAR-based estimates, the paper finds that the exchange rate pass-through to import prices for a large number of countries is incomplete and larger than the pass-through to export prices.
The observed empirical puzzle: local currency pricing is needed to account for incomplete import price pass-through, but it would not imply a lower export price pass-through.
The paper proposes an alternative explanation: the presence of both producer and local currency pricing can reconcile the empirical pass-through patterns even with a constant markup.
The model can also explain:
- the observed exchange rate and inflation variability, and
- the fact that the regression and VAR estimates tend to be similar.

Empirical approaches:
- Regression-based estimates.
- VAR-based estimates.
Theoretical approach:
- A dynamic general equilibrium model incorporating a mix of producer currency pricing and local currency pricing.
Comparison to prior literature:
- Recent explanations emphasized markup adjustment in response to exchange rate changes; this paper offers a different mechanism based on currency pricing mix.

Key mechanism:
- A mix of producer and local currency pricing generates incomplete exchange rate pass-through to import prices and a larger pass-through to import than to export prices without requiring variable markups.
Implications for understanding pass-through:
- Currency choice by firms (producer vs. local currency pricing) is a central determinant of pass-through patterns.
- Constant markup settings can still produce the documented empirical regularities when currency pricing is heterogeneous.