Trade Integration, Competition, and the Decline in Exchange-Rate Pass-Through

51 Pages Posted: 31 Aug 2006

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: August 2006

Abstract

Over the past twenty years, U.S. import prices have become less responsive to the exchange rate. We propose that a significant portion of this decline is a result of increased trade integration. To illustrate this effect, we develop an open economy DGE model in which trade occurs along both the intensive and extensive margins. The key element we introduce into this environment is strategic complementarity in price setting. As a result, a firm's pricing decision depends on the prices set by its competitors. This feature implies that a foreign exporter finds it optimal to vary its markup in response to shocks that change the exchange rate, insulating import prices from exchange rate movements. With increased trade integration, exporters have become more responsive to the prices of their competitors and this change in pricing behavior accounts for a significant portion of the observed decline in the sensitivity of U.S import prices to the exchange rate.

Keywords: Pass-through, trade integration, strategic complementarity

JEL Classification: F15, F41

Suggested Citation

Gust, Christopher and Leduc, Sylvain and Vigfusson, Robert John, Trade Integration, Competition, and the Decline in Exchange-Rate Pass-Through (August 2006). FRB International Finance Discussion Paper No. 864, Available at SSRN: https://ssrn.com/abstract=927728 or http://dx.doi.org/10.2139/ssrn.927728

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

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
103
Abstract Views
719
rank
312,197
PlumX Metrics