The Pass-Through of Exchange Rate Changes to Import Prices

In this paper we analyze the empirical relevance of exchange rate pass through for Finland, Sweden and Denmark during the period 1980–1994. Further, we attempt to determine if there has been a structural change in the pass-through relationship in the1990s. We find that about half the changes in exchange rates and world prices are passed through to import prices within one year, and three-quarters of such changes are passed through to import prices in two years. Moreover, there are no major differences among countries. Parameter constancy tests indicate the possibility of a structural change where the pass-through has slowed in recent years. Possible explanations of this are that the exchange rate regime has changed and competition has increased.

Introduction: The breakdown of the Bretton Woods system gave way to large exchange rate fluctuations with an enormous impact on trade flows. The pricing strategies and the costs of production (depending on the imported inputs) of international companies changed dramatically. This period also saw the emergence of a certain asynchronism between observed exchange rate and price movements. The large swings of the dollar in the 1980s, for example, did not have the theoretically expected effect on US import prices, domestic inflation, trade balance, or current account. One might expect that a nominal appreciation of the importing country’s currency should also lead to an equivalent decrease in import prices denominated in the importing country’s currency, and that the depreciation of the exchange rate should give way to an equivalent fall in import prices denominated in the importing country’s currency. In fact, US import prices do not well reflect the appreciation of the dollar prior to 1985. After 1985, however, US export prices more closely follow dollar depreciation.
These fluctuations cannot be explained simply as differences in productivity growth across countries.’

Author: Uwe Ketelse, Mika Kortelainen

Source: Research Discussion Papers, Bank of Finland

Download URL 2: Visit Now

Leave a Comment