Degree of Monopoly, Pricing and Flexible Exchange Rates

Abstract

Exchange-rate pass-through is the degree to which a change in the exchange rate is translated into a change in the price of internationally traded goods. The pass-through question took on great importance in the United State in the 1980s with the persistence of its trade deficit in the face of a large depreciation of the dollar. Some delay in adjustment was expected according to the J-curve phenomenon. When the J-curve appeared not to be turning upward, economists began to attribute the intransigence of the US trade deficit in part to the rigidity of prices despite the huge currency shift.¹ Explanations of these deviations from the law of one price, however, vary widely. In this chapter we extend some well-known PKE pricing models in an attempt to explain the limited passthrough phenomenon.