Exchange Rate Pass-through and Market Structure in Multi-country World

 

 

David Hummels, Purdue University and NBER

 

Kanda Naknoi, Purdue University

 

 

October 2009

 

 

Abstract

 

Micro-estimates of exchange rate pass-through (ERPT) yield elasticities well outside the range of values predicted by theory.  We provide a multi-country quadratic utility model that allows us to examine how export prices are affected by movements in own-currency and cross-currency exchange rates.  Own-currency appreciations move firms along a linear demand curve while cross-currency appreciations shift the position of that demand curve.  Both affect the firm's elasticity of demand and therefore the degree to which exchange rate movements affect prices.  When own- and cross-currency exchange rates are correlated, as when the euro rises in value against both the dollar and the yen, this yields EPRT elasticities that match facts.  The model also yields testable predictions for how firms respond to cross-currency exchange rate shocks even when there is no movement in the own exchange rate.