Exchange Rate Pass-Through: A Competitive Search Approach

Beverly Lapham and Ayman Mnasri ()
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Ayman Mnasri: Qatar University

No 1418, Working Paper from Economics Department, Queen's University

Abstract: We develop an open economy monetary model with heterogeneous households which is characterized by incomplete pass-through of exchange rate movements to import prices. Partial pass-through arises in our environment due to the presence of competitive search in international goods' markets. Under competitive search, agents choose a sub-market in which to exchange goods, where different sub-markets are characterized by different price and trading probability combinations. Preference and policy shocks which induce exchange rate movements cause households to choose a different sub-market for their purchases of traded goods--an extensive margin response. These responses mitigate the direct effect of nominal exchange rate changes on equilibrium traded goods' prices, thereby generating incomplete exchange rate pass-through to goods' prices. In the calibrated model, exchange rate pass-through due to foreign shocks ranges between 19% and 62%, which is in the range of import price pass-through estimates for developed economies. Due to risk aversion by households, the magnitude of pass-through depends on the size and direction of the initial shock, making the model consistent with the observed phenomenon of asymmetric pass-through. Importantly, by incorporating household heterogeneity, we are able to examine the role of precautionary savings in affecting pass-through, characterize how pass-through varies across different types of households, and examine the distributional effects of exchange rate movements.

Keywords: Exchange Rate Pass-Through; Competitive Search; Monetary Policy (search for similar items in EconPapers)
JEL-codes: E58 F31 O24 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2019-06
New Economics Papers: this item is included in nep-dge, nep-int, nep-mac, nep-mon and nep-opm
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