Advertisement

Review of World Economics

, Volume 148, Issue 3, pp 523–552 | Cite as

A regime-switching analysis of pass-through

  • Kolver Hernandez
  • Aslı Leblebicioğlu
Original Paper

Abstract

We empirically investigate how various economic factors affect the changes in the pricing policies of exporters, in particular changes in the exchange rate pass-through. Assuming exporters set prices following either a high or a low pass-through pricing policy, and assuming that the transition probabilities between these pricing policies depend on market concentration, exporting country’s market share and monetary stability, we estimate a Markov regime-switching model, using data we have collected on imported cars to the United States. Our findings show that the “low pass-through” regime is characterized by: lower exchange rate pass-through, low response to misalignments in the firm’s relative price, low volatility of exogenous shocks, and higher duration. When we decompose the changes in the pass-through in our sample, we find that monetary stability has been the most important factor behind the decline in the pass-through. Monetary stability explains more than 50% of the decline in the exchange rate pass-through, while country market share and market concentration explain about 25 and 10%, respectively.

Keywords

Exchange rate pass-through Markov regime-switching 

JEL Classification

F31 F40 

Notes

Acknowledgments

We thank the editor, Harmen Lehment, and an anonymous referee, Fabio Ghironi, Tom Grennes, Nan Li, Catherine L. Mann, Helen Naughton, Katheryn Russ, Tanseli Savaser and Martha Starr for their helpful suggestions and comments. We also thank the seminar participants at the Board of Governors of the Federal Reserve System, the University of Delaware, North Carolina State University and the University of Oklahoma for their comments. Any error is ours.

References

  1. Ayres, I., & Siegelman, P. (1995). Race and gender discrimination in bargaining for a new car. American Economic Review, 85(3), 304–321.Google Scholar
  2. Bacchetta, P., & van Wincoop E. (2005). A theory of the currency denomination of international trade. Journal of International Economics, 67(2), 295–319.CrossRefGoogle Scholar
  3. Bodnar, G. M., Dumas, B., & Marston, R. C. (2002). Pass-through and exposure. Journal of Finance 57(1), 199–231.CrossRefGoogle Scholar
  4. Burstein, A. T., Neves, J. C., & Rebelo, S. (2003). Distribution costs and real exchange rate dynamics during exchange-rate-based stabilizations. Journal of Monetary Economics, 50(6), 1189–1214.CrossRefGoogle Scholar
  5. Campa, J. M., & Goldberg, L. S. (2005). Exchange rate pass-through into import prices. The Review of Economics and Statistics, 87(4), 679–690.CrossRefGoogle Scholar
  6. Corsetti, G., & Dedola, L. (2004). A macroeconomic model of international price discrimination. Journal of International Economics, 67(1), 129–155.CrossRefGoogle Scholar
  7. Devereux, M. B., Engel, C., & Storgaard, P. E. (2004). Endogenous exchange rate pass-through when nominal prices are set in advance. Journal of International Economics, 63(2), 263–291.CrossRefGoogle Scholar
  8. Diebold, F. X., Lee, J.-H., & Weinbach, G. C. (1993). Regime switching with time-varying transition probabilities. (Working Papers 93-12), Federal Reserve Bank of Philadelphia.Google Scholar
  9. Donnenfeld S., & Zilcha, I. (1991). Pricing of exports and exchange rate uncertainty. International Economic Review, 32(4), 1009–1022.CrossRefGoogle Scholar
  10. Dotsey, M., & King, R. G. (2005). Implications of state-dependent pricing for dynamic macroeconomic models. Journal of Monetary Economics, 52(1), 213–242.CrossRefGoogle Scholar
  11. Engel, C. (2006). Equivalence results for optimal pass-through, optimal indexing to exchange rates, and optimal choice of currency for export pricing. Journal of the European Economic Association, 4(6), 1249–1260.CrossRefGoogle Scholar
  12. Feenstra, R. C. (1994). New product varieties and the measurement of international prices. American Economic Review, 84(1), 157–177.Google Scholar
  13. Feenstra, R. C., Gagnon, J. E., & Knetter, M. M. (1996). Market share and exchange rate pass-through in world automobile trade. Journal of International Economics, 40(1–2), 187–207.CrossRefGoogle Scholar
  14. Frankel, J. A., Parsley, D. C. &, Wei, S.-J. (2005). Slow passthrough around the world: A new import for developing countries? (NBER Working Papers 11199). Cambridge, MA: National Bureau of Economic Research.Google Scholar
  15. Friberg, R. (1998). In which currency should exporters set their prices? Journal of International Economics, 45(1), 59–76.CrossRefGoogle Scholar
  16. Froot, K. A., & Klemperer, P. D. (1989). Exchange rate pass-through when market share matters. American Economic Review, 79(1), 59–76.Google Scholar
  17. Giovannini, A. (1998). Exchange rates and traded goods prices. Journal of International Economics, 24(1–2), 45–68.Google Scholar
  18. Goldberg, L. S., & Tille, C. (2008). Vehicle currency use in international trade. Journal of International Economics, 76(2), 177–192.CrossRefGoogle Scholar
  19. Goldberg, P. K. (1996). Dealer price discrimination in new car purchases: Evidence from the consumer expenditure survey. Journal of Political Economy, 104(3), 622–654.CrossRefGoogle Scholar
  20. Goldberg, P. K., & Verboren, F. (2001). The evolution of price dispersion in European car markets. Review of Economic Studies, 68(4), 811–848.CrossRefGoogle Scholar
  21. Goldberg, P. K., & Verboren, F. (2005). Market integration and convergence to the law of one price: Evidence from the European car market. Journal of International Economics, 65(1), 49–73.CrossRefGoogle Scholar
  22. Gopinath, G., & Rigobon, R. (2008). Sticky borders. Quarterly Journal of Economics, 123(2), 531–575.CrossRefGoogle Scholar
  23. Gron, A., & Swenson, D. L. (1996). Incomplete exchange-rate pass-through and imperfect competition: The effect of local production. American Economic Review Papers and Proceedings, 86(2), 71–76.Google Scholar
  24. Hamilton, J. D. (1990). Analysis of time series subject to changes in regime. Journal of Econometrics, 45(1–2), 39–70.CrossRefGoogle Scholar
  25. Hamilton, J. D. (1996). Specification testing in Markov-switching time-series models. Journal of Econometrics, 70(1), 127–157.CrossRefGoogle Scholar
  26. Hamilton, J. D. (2008). Regime switching models. In S. N. Durlauf & L. E. Blume (Eds.), The new palgrave dictionary of economics (2nd ed.). Palgrave Macmillan Online.Google Scholar
  27. Hellerstein, R. (2005). A decomposition of the sources of incomplete cross-border transmission: The case of beer. (Working Paper), Federal Reserve Bank of New York.Google Scholar
  28. Hellerstein, R. (2008). Who bears the cost of a change in the exchange rate? Pass-through accounting for the case of beer. Journal of International Economics, 76(1), 14–32.CrossRefGoogle Scholar
  29. Kimball, M. S. (1995). The quantitative analytics of the basic neomonetarist model. Journal of Money, Credit and Banking, 27(4), 1241–1277.CrossRefGoogle Scholar
  30. Knetter, M. M. (1993). International comparisons of pricing-to-market behavior. American Economic Review, 83(3), 473–486.Google Scholar
  31. Krugman, P. (1987) Pricing to market when the exchange rate changes. In: S. W. Arndt & J. D. Richardson (Eds.). Real-financial linkages among open economies (2nd ed). Cambridge: MIT Press.Google Scholar
  32. Mann, C. L. (1986). Prices, profit margins, and exchange rates. Federal Reserve Bulletin, pp. 366–379.Google Scholar
  33. Marazzi, M., & Sheets, N. (2007). Declining exchange rate pass-through to U.S. import prices: The potential role of global factors. Journal of International Money and Finance, 26(6), 924–947.CrossRefGoogle Scholar
  34. Marazzi, M., Sheets, N., Vigfusson, R. J., Faust, J., Gagnon, J., Marquez, J., Martin, R. F., Reeve, T., & Rogers, J. (2005). Exchange rate pass-through to U.S. import prices: Some new evidence. (International Finance Discussion Papers 833). Board of Governors of the Federal Reserve System (U.S.).Google Scholar
  35. Marston, R. C. (1990). Pricing to market in Japanese manufacturing. Journal of International Economics, 29(3–4), 217–236.CrossRefGoogle Scholar
  36. Meng, X.L., & Rubin, D.B. (1991). Using EM to obtain asymptotic variance-covariance matrices: The SEM algorithm. Journal of the American Statistical Association, 86(416), 899–909.CrossRefGoogle Scholar
  37. Nakamura, E., & Zerom, D. (2010). Accounting for incomplete pass-through. Review of Economic Studies, 77(3), 1192–1230.CrossRefGoogle Scholar
  38. Taylor, J. B. (2000). Low inflation, pass-through, and the pricing power of firms. European Economic Review, 44(7), 1389–1408.CrossRefGoogle Scholar

Copyright information

© Kiel Institute 2012

Authors and Affiliations

  1. 1.Department of EconomicsUniversity of DelawareNewarkUSA
  2. 2.Department of EconomicsNorth Carolina State UniversityRaleighUSA

Personalised recommendations