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Exchange Rate, External Orientation of Firms and Wage Adjustment

Authors


  • This project was begun while Alberto Pozzolo was with the Research Department of the Bank of Italy. We are especially grateful to two anonymous referees for their helpful comments, and we also thank Linda Goldberg, Paolo Naticchioni and seminar participants at the IEA Conference in Beijing, the University of Trento and the XIX Tor Vergata University Conference on Money, Banking and Finance (Rome) for useful discussions.

Abstract

We estimate the effect of exchange rate movements on firm-level wages, using a representative panel of Italian manufacturing firms. We show that the direction and size of wage adjustment is shaped by the international exposure of each firm on both the sale and cost side of the balance sheet, similar to the response of employment documented in (Nucci and Pozzolo, Journal of International Economics 2010; 82: 112.). Through the revenue side, wages tend to rise after a currency depreciation and the effect is more pronounced the higher is the firm's exposure to sales from exports. Through the expenditure side, a depreciation induces a cut in the firm's wages, and the effect is larger the higher is the incidence of imported inputs in total production costs. For a given degree of external orientation, both these effects are larger for firms with a lower market power. Moreover, we document that the effect of exchange rates on wages is shaped by the extent of sectoral import penetration in the domestic market.

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