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Exchange rate pass-through to import prices: accounting for changes in the eurozone trade structure

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Abstract

This paper assesses the effect of the emergence of new trading partners (i.e., China and Eastern Europe) on the exchange rate pass-through (ERPT) to import prices in eurozone countries. To this end, we rely on bilateral data on imports of manufactured goods at the two-digit sector level over the 2000–2018 period. We find that (i) pass-through is complete in many cases, (ii) ERPT from China is higher than from the United States, and (iii) there is no generalized link between ERPT and the increasing integration of some emerging markets in European imports. We also show that the launch of the single currency has not provoked a sufficient change in the part of trade exposed to exchange rate fluctuations and, therefore, has not affected the pass-through.

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Notes

  1. The role of market structure and product differentiation matters when considering the industry or product level. Indeed, incomplete ERPT is generally found for heterogeneous products (such as differentiated manufactured goods, machinery and transport equipment), while more homogeneous goods (such as oil and raw materials) usually exhibit higher ERPT degrees. The shift in the composition of imports towards sectors characterized by lower ERPT degrees could be an explanation for the declining ERPT at the aggregated level. This is, for instance, the case for differentiated manufactured goods for which pricing-to-market strategy is more frequent (see, e.g., Campa et al. 2005; Ben Cheikh and Rault 2016).

  2. See Jimborean (2013) for an investigation of the exchange rate pass-through to import, producer, and consumer prices for a panel of Central and Eastern European countries.

  3. For the sake of completeness, note that high ERPT into import prices allows the use of the exchange rate as an instrument for correcting external imbalances, whereas low ERPT into consumer prices avoids inflationary pressures to the domestic economy.

  4. These statistics are extracted from Marin (2017).

  5. Some studies suggest that the creation of EMU might have stimulated intra-area trade at the expense of that taking place with the rest of the world. See, for instance, Faruqee (2004).

  6. See, e.g., Schroder and Hufner (2002), Anderton (2003), Hahn (2003), Campa et al. (2005), Campa and Gonzàlez-Mínguez (2006), Faruqee (2006), and Ben Cheikh and Rault (2016).

  7. It is worth mentioning that this argument may be counterbalanced by the fact that countries may also become more differentiated, due to rising specialization across euro area countries (see Krugman and Venables 1996).

  8. See Chen and Engel (2005), Imbs et al. (2005), and Gadea and Mayoral (2009).

  9. Using effective exchange rates and import prices, Campa et al. (2005) show that short-run ERPT is high, although incomplete, and that it differs across industries and countries.

  10. Gopinath et al. (2010) show substantial differences in ERPT rates regarding the specific US trading partner. For instance, the average pass-through rate for German imports into the US is 63% (17%) higher for dollar priced (non-dollar priced) goods compared to imports from the UK.

  11. We select these four countries as the European Union-28 (including UK), China, the United States, and Japan are the largest global players for international trade goods (source: Eurostat). See Sect. 3.1 for more details.

  12. Roughly speaking, two main approaches are generally used to estimate the pass-through (for a detailed discussion, see Aron et al. 2014): (i) the structural VAR models (McCarthy 2007), and (ii) a unique equation expressed in first differences (Campa et al. 2005).

  13. Due to space constraints, this long-run analysis is reported in the online Appendix B.

  14. Note that our specification includes the determinants traditionally retained in the literature on ERPT (see, e.g., Goldberg and Knetter 1997; Campa et al. 2005; Aron et al. 2014). For the sake of completeness, it is worth mentioning that, regarding the proxy for foreign firms’ markup, some studies have also used the domestic producer prices as an indicator of the competitors’ prices in the importing country (see, e.g., Olivei 2002; Bussiere 2013). Unfortunately, these data are not available for China at this level. Similarly, some papers (e.g., Ben Cheikh and Rault 2017) include the output gap in the ERPT equation. Although this variable can be used as an indicator of domestic demand changes, its main drawback is that its construction requires the evaluation of the “potential” real GDP. The latter is typically assessed through filtering the GDP series, which may be viewed as somewhat arbitrary.

  15. Time-specific effects are accounted for through various explanatory variables, namely GDP, exchange rates, oil prices, and marginal costs.

  16. Results of cross-sectional dependence, panel unit root, and panel cointegration tests are reported in the online Appendix in Tables B1–B3. The results related to the estimation of the error-correction model are displayed in Table B4.

  17. See Bergin et al. (2013, 2014) for more details on the estimation methodology.

  18. Note that an alternative would have been to use foreign exporters’ unit labor costs, but such data was unavailable for China.

  19. Note that intra-EMU data includes new member States when they joined the Union.

  20. See Menon (1995) and Engel (2002) for a survey, and Campa and Goldberg (2005), Marazzi and Sheets (2007), Bouakez and Rebei (2008), or Gust et al. (2010) and Ben Cheikh and Rault (2016) for more recent empirical studies.

  21. Their application concerns Colombia, a small open economy that displays heavy reliance on dollar as 98% of its exports are invoiced in the US currency.

  22. These figures are based on data extracted from the International Trade Center.

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Authors and Affiliations

  1. EconomiX-CNRS, University of Paris Nanterre, Nanterre, France

    Antonia López-Villavicencio & Valérie Mignon

  2. CEPII, International Macroeconomics and Finance Research Group, Paris, France

    Valérie Mignon

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  1. Antonia López-Villavicencio
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  2. Valérie Mignon
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Correspondence to Valérie Mignon.

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López-Villavicencio, A., Mignon, V. Exchange rate pass-through to import prices: accounting for changes in the eurozone trade structure. Rev World Econ 156, 835–858 (2020). https://doi.org/10.1007/s10290-020-00382-2

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