Exchange Rate Pass-Through When Market Share Matters

Abstract

We investigate pricing to market when the exchange rate changes in cases where firms' future demands depend on their current market shares. We show that i) profit maximizing foreign firms may either raise or lower their domestic currency export prices when the domestic exchange rate appreciates temporarily (i.e. the "pass-through" from exchange rate changes to import prices may be perverse); ii) current import prices may be more sensitive to the expected future exchange rate than to the current exchange rate; iii) current import prices fall in response to an increase in uncertainty about the future exchange rate. We present evidence that suggests the behavior of expected future exchange rates may provide a clue to the puzzling behavior of U.S. import prices during the 1980s.