The Federal Reserve Board eagle logo links to Board's home page

International Finance Discussion Papers
The International Finance Discussion Papers logo links to the International Finance Discussion Papers home page Trade Integration, Competition, and the Decline in Exchange-Rate Pass-Through
Christopher Gust, Sylvain Leduc, and Robert J. Vigfusson
2006-864  (August 2006)

Abstract:  Over the past twenty years, U.S. import prices have become less responsive to the exchange rate. We propose that a significant portion of this decline is a result of increased trade integration. To illustrate this effect, we develop an open economy DGE model in which trade occurs along both the intensive and extensive margins. The key element we introduce into this environment is strategic complementarity in price setting. As a result, a firm's pricing decision depends on the prices set by its competitors. This feature implies that a foreign exporter finds it optimal to vary its markup in response to shocks that change the exchange rate, insulating import prices from exchange rate movements. With increased trade integration, exporters have become more responsive to the prices of their competitors and this change in pricing behavior accounts for a significant portion of the observed decline in the sensitivity of U.S import prices to the exchange rate.

Full paper (479 KB PDF) | Full paper (screen reader version)

Pass-through, trade integration, strategic complementarity

PDF files: Adobe Acrobat Reader   ZIP files: PKWARE

Home | IFDPs | List of 2006 IFDPs
Accessibility | Contact Us
Last update: August 22, 2006