Import Price Dynamics in Major Advanced Economies and Heterogeneity in Exchange Rate Pass-Through

This paper aims at showing heterogeneity in the degree of exchange rate pass-through to import prices in major advanced economies at three di¤erent levels: 1) across destination markets ; 2) across types of exporters (distinguishing developed economy from emerging economy exporters); and 3) over time. Based on monthly data over the period 1991-2007, the results show …rst that large destination markets exhibit the lowest degree of pass-through. The degree of pass-through for goods imported from emerging economies is also signi…cantly lower than for those from developed economies. Regarding the evolution over time, no clear change in pricing behaviours can be identi…ed and particular events, like large exchange rates depreciations during the Asian crisis, seem to in‡uence the degree of pass-through related to imports from emerging economies. Keywords: Pricing to Market, Exchange rate pass-through, Import price modeling. JEL Classi…cation: E31, F3, F41. 4 ECB Working Paper Series No 933 September 2008 Non-technical summary Several empirical studies show that exchange rate pass-through to import prices has declined in major advanced economies over the past decades. While the source of the decline in pass-through is di¢ cult to identify, the period also corresponds to a rise in trade integration with emerging economies (EEs hereafter). If the decline in exchange rate pass-through had been related to the increasing importance of EEs in major advanced economies’imports, this would suggest that EE exporters have a pricing behaviour that di¤ers signi…cantly from exporters from developed economies (DEs thereafter). Exporters from a given country may choose a di¤erent pricing strategy than exporters from another country as a result of di¤erences in the composition of the goods that they export leading to di¤erent degrees of pass-through in the importer country. Also, because EE …rms would like to gain market shares in the advanced economies, they would tend to follow a pricing-to-market behaviour when exporting to these markets. As a result, their exchange rate pass-through is lower as a way to remain competitive in these markets. Although one could argue the opposite by stressing that EEs export less sophisticated goods with lower pro…t margins and therefore have lower ability to bu¤er the impact of exchange rate changes. Competitive pressures can be so strong for some types of goods that …rms are constrained by their competitors’pricing decisions. Another important aspect concerns the di¤erent degree of pass-through across importing countries. The U.S. are shown to exhibit lower pass-through than other advanced economies. The relative importance of EEs in the composition of imports might partly explain these di¤erences. The size of the market might also matter with exporters tending to follow higher pricing-to-market strategy to large and competitive markets (where a large number of exporters compete) relative to small and less competitive ones. Based on monthly data over the period 1991-2007, this paper aims at showing heterogeneity in the degree of exchange rate pass-through to import prices 5 ECB Working Paper Series No 933 September 2008 in major advanced economies at three di¤erent levels: 1) across destination markets ; 2) across types of exporters (distinguishing developed economy from emerging economy exporters); and 3) over time. The results show …rst evidence of di¤erences in exchange rate pass-though to import prices across major advanced economies. The U.S. has the lowest degree of pass-through, while Japan and Canada have the highest. Pass-through to European economies’import prices lies somewhere in between. This result has been explained by the tendency for exporters to adopt a pricing-to-market strategy for large, competitive markets like the U.S. These results also support the negative relationship between the share of imports invoiced in the local currency and the degree of exchange rate pass-through. Second the results show that the degree of pass-through for EE exporters is in general lower than for DE ones. Finally, no clear trend in the degree of pass-through (whether downwards or upwards) has been identi…ed over the period considered (19912006). However, particular events, like large exchange rate depreciations during the Asian crisis, seem to have greatly in‡uenced the degree of pass-through. 6 ECB Working Paper Series No 933 September 2008