Why Do Consumer Prices React Less than Import Prices to Exchange Rates?

28 Pages Posted: 21 Nov 2002 Last revised: 1 Jun 2011

See all articles by Philippe Bacchetta

Philippe Bacchetta

University of Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Eric van Wincoop

University of Virginia - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: November 2002

Abstract

It is well known that the extent of pass-through of exchange rate changes to consumer prices is much lower than to import prices. One explanation is local distribution costs. Here we consider an alternative, complementary, explanation based on the optimal pricing strategies of firms. We consider a model where foreign exporting firms sell intermediate goods to domestic firms. Domestic firms assemble the imported intermediate goods and sell final goods to consumers. When domestic firms face significant competition from other domestic final goods producing sectors (e.g., the non-traded goods sector) we show that they prefer to price in domestic currency, while exporting firms tend to price in the exporter's currency. In that case the pass-through to import prices is complete, while the pass-through to consumer prices is zero.

Suggested Citation

Bacchetta, Philippe and van Wincoop, Eric, Why Do Consumer Prices React Less than Import Prices to Exchange Rates? (November 2002). NBER Working Paper No. w9352, Available at SSRN: https://ssrn.com/abstract=353762

Philippe Bacchetta

University of Lausanne ( email )

Faculty of Business and Economics
Internef 523
1015 Lausanne
Switzerland

HOME PAGE: http://www.hec.unil.ch/pbacchetta/

Centre for Economic Policy Research (CEPR)

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United Kingdom

Swiss Finance Institute

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Eric Van Wincoop (Contact Author)

University of Virginia - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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