Entry Dynamics and the Decline in Exchange-Rate Pass-Through

39 Pages Posted: 14 Nov 2010

See all articles by Christopher Gust

Christopher Gust

Board of Governors of the Federal Reserve System

Sylvain Leduc

Federal Reserve Banks - Federal Reserve Bank of San Francisco

Robert J. Vigfusson

Board of Governors of the Federal Reserve System

Date Written: October 22, 2010

Abstract

The degree of exchange-rate pass-through to import prices is low. An average pass-through estimate for the 1980s would be roughly 50 percent for the United States implying that, following a 10 percent depreciation of the dollar, a foreign exporter selling to the U.S. market would raise its price in the United States by 5 percent. Moreover, substantial evidence indicates that the degree of pass-through has since declined to about 30 percent.

Gust, Leduc, and Vigfusson (2010) demonstrate that, in the presence of pricing complementarity, trade integration spurred by lower costs for importers can account for a significant portion of the decline in pass-through. In our framework, pass-through declines solely because of markup adjustments along the intensive margin.

In this paper, we model how the entry and exit decisions of exporting firms affect pass-through. This is particularly important since the decline in pass-through has occurred as a greater concentration of foreign firms are exporting to the United States.

We find that the effect of entry on pass-through is quantitatively small and is more than offset by the adjustment of markups that arise only along the intensive margin. Even though entry has a relatively small impact on pass-through, it nevertheless plays an important role in accounting for the secular rise in imports relative to GDP. In particular, our model suggests that over 3/4 of the rise in the U.S. import share since the early 1980s is due to trade in new goods.

Thus, a key insight of this paper is that adjustment of markups that occur along the intensive margin are quantitatively more important in accounting for secular changes in pass-through than adjustments that occur along the extensive margin.

Keywords: Pass-through, trade integration, strategic complementarity, intensive margin

JEL Classification: F15, F41

Suggested Citation

Gust, Christopher and Leduc, Sylvain and Vigfusson, Robert John, Entry Dynamics and the Decline in Exchange-Rate Pass-Through (October 22, 2010). FRB International Finance Discussion Paper No. 1008, Available at SSRN: https://ssrn.com/abstract=1708206 or http://dx.doi.org/10.2139/ssrn.1708206

Christopher Gust (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Sylvain Leduc

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

Robert John Vigfusson

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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