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Exchange Rate Pass-through to Trade Prices: The Role of Nonlinearities and Asymmetries

Authors


  • This article is a revised version of ECB Working Paper No. 822. I am very grateful to an anonymous referee and to the Editor, Christopher Adam, for very constructive comments on the initial draft. I also would like to thank, for helpful comments and suggestions, Anindya Banerjee, Agnès Bénassy-Quéré, Menzie Chinn, Joseph Gagnon, Jean Imbs, Jaime Marquez, Peter McAdam, Robert Martin, Arnaud Mehl, Isabelle Méjean, Trevor Reeve, Michael Sager, Lucio Sarno, Timo Teräsvirta, Dick van Dijk, as well as seminar participants at the European Central Bank in Frankfurt, at the Federal Reserve Board in Washington DC, at the Annual Congress of the European Economic Association in Vienna, at the 2007 Econometric Workshop on ‘‘Nonlinear Dynamical Methods and Time Series Analysis’’ in Udine and at the 2007 Annual Meeting of the American Economic Association. The views expressed in the paper are those of the author and do not necessarily reflect those of the ECB, the Banque de France, or the Eurosystem.

Abstract

A standard assumption in the empirical literature is that exchange rate pass-through is both linear and symmetric. This study tests these assumptions for export and import prices in the G7 economies. It focuses on non-linearities in the reaction of profit margins to exchange rate movements, which may arise from the presence of price rigidities and switching costs. Nonlinearities are characterized by augmenting a standard linear model with polynomial functions of the exchange rate and with interactive dummy variables. The results suggest that nonlinearities and especially asymmetries cannot be ignored, although their magnitude varies noticeably across countries.

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