Exchange-rate pass-through (ERPT) is a measure of how responsive international prices are to changes in exchange rates.

Formally, exchange-rate pass-through is the elasticity of local-currency import prices with respect to the local-currency price of foreign currency. It is often measured as the percentage change, in the local currency, of import prices resulting from a one percent change in the exchange rate between the exporting and importing countries.[1] A change in import prices affects retail and consumer prices. When exchange-rate pass-through is greater, there is more transmission of inflation between countries.[2] Exchange-rate pass-through is also related to the law of one price and purchasing power parity.

Example

Suppose that the US imports widgets from the UK. The widgets cost $10 and £1 costs $1. Then the British Pound appreciates against the dollar and now £1 costs $1.50. Also suppose that the widgets now cost $12.5

There has been a 50% change in the exchange rate and a 25% change in price. The exchange rate pass-through is

For every 1% increase in the exchange rate, there has been a .5% increase in the price of the widgets.

Measurement

The "standard pass-through regression"[3] is

where is import price, is the exchange rate, is marginal costs, is demand, and denotes a first difference. The exchange-rate pass-through after periods is

Campa and Goldberg (2005) estimated the long-run exchange-rate pass-through to import prices for the following countries, averaging across the countries from which imports came:[2]

CountryLong-Run Exchange-Rate Pass-Through[2]
Australia0.69
Canada0.68
Switzerland0.94
Czech Republic0.61
Germany0.79
Denmark0.68
Spain0.56
Finland0.82
France1.21
United Kingdom0.47
Hungary0.85
Ireland1.37
Iceland0.76
Italy0.62
Japan1.26
Netherlands0.77
Norway0.79
New Zealand0.62
Poland0.99
Portugal0.88
Sweden0.59
USA0.41

Measurement of exchange-rate pass-through is typically performed using aggregate price indexes.[1] Some studies have examined how firms in different industries or with different production costs differ in their responses to exchange rates. Studies of firm-level differences explain why exchange-rate pass-through is not equal to one[4] and how globalization caused a decrease in exchange-rate pass-through.[5]

References

  1. 1 2 Goldberg, P.K.; Knetter, M.M. (1997). "Goods prices and exchange rates: What have we learned?". Journal of Economic Literature. 35 (3): 1243–1272. doi:10.3386/w5862.
  2. 1 2 3 Campa, J.M.; Goldberg, L.S. (2005). "Exchange Rate Pass-Through into Import Prices". Review of Economics and Statistics. 87 (4): 679–690. doi:10.1162/003465305775098189. S2CID 57558745. (2002 NBER Working Paper version, doi:10.3386/w8934)
  3. Gopinath, G.; Rigobon, R. (2008). "Sticky Borders". Quarterly Journal of Economics. 123 (2): 531–575. doi:10.1162/qjec.2008.123.2.531.
  4. Berman, N.; Martin, P.; Mayer, T. (2012). "How do Different Exporters React to Exchange Rate Changes?". Quarterly Journal of Economics. 127 (1): 437–492. doi:10.1093/qje/qjr057.
  5. Cook, J.A. (2014). "The Effect of Firm-Level Productivity on Exchange Rate Pass-Through". Economics Letters. 122 (1): 27–30. doi:10.1016/j.econlet.2013.10.028.
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