Pass-through of Exchange Rates and Competition Between Floaters and Fixers
National Bureau of Economic Research, 2007 - Foreign exchange rates - 45 pages
This paper studies how a rise in China's share of U.S. imports could lower pass-through of exchange rates to U.S. import prices. We develop a theoretical model with variable markups showing that the presence of exports from a country with a fixed exchange rate could alter the competitive environment in the U.S. market. In particular, this encourages exporters from other countries to lower markups in response to a U.S. depreciation, thereby moderating the pass-through to import prices. Free entry is found to further moderate the pass-through, in that a U.S. depreciation encourages entry of exporters whose costs are shielded by the fixed exchange rate, which further intensifies the competitive pressure on other exporters. The model predicts that certain conditions are necessary to facilitate this 'China explanation' for falling pass-through, including a 'North America bias' in U.S. preferences. The model also produces a log-linear structural equation for pass-through regressions indicating how to include the China share. Panel regressions over 199361999 support the prediction that a high China share in imports lowers pass-through to U.S. import prices.
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5-digit Enduse industry asset market equilibrium cash-in-advance constraint China share Chinese competition Chinese firms Chinese import share Chinese money supply Chinese wage cointegrated consumer denoted differentiated products disaggregate dollar depreciation effective exchange rate eigenvalue endogenous Enduse categories exchange rate movements exporters FE-OLS Feenstra fixed costs fixed exchange rate free entry implies Import tariff incomplete pass-through increase interaction term ln(eywy lne(p lower pass-through Marazzi market equilibrium condition market share markups matrix maximum likelihood Mexican and Chinese Mexico and China monopolistic competition multilateral exchange rate NAFTA non-ITA number of Chinese number of firms number of products obtain panel parameters pass-through coefficient pass-through of exchange pass-through regressions peso exchange rate price equation price index reservation prices root test share of imports share of U.S. short-run solve subscriptions third term translog expenditure function U.S. dollar U.S. money supply unit root variables vector zero zero-profit