Question

Exchange Rate Pass-through: I have read about a study by Gopinath, Itskhoki, and Rigobon (2010) about the currency which importers decide to price their goods in. The study suggests that if an importer wants low passthrough rate (e.g. 0-20%), it will price in USD. If an importer wants high passthrough rate (e.g. 100%), it will price in non-Dollar curencies. Can someone explain why an importer would want 100% passthrough versus 0% passthrough? How does this impact an importer choosing to price in local currency versus the foreign currency?

Answer 1

An exchange rate pass through effect measures the percentage change in the prices of imports as a result of a given percentage change in the exchange rate. A hundred percent pass-through effect is selected by the importers when they believe that the elasticity of demand for imported goods is zero so that import demand is perfectly inelastic to price. When import demand is perfectly inelastic any change in the import price will not affect the quantity demanded of imports and hence a hundred Percent pass through effect can be applied.

In contrast 0% pass through effect is applicable when the import demand is perfectly elastic. This indicates that the importer is not willing to accept any change the price of its imports because the import demand is highly sensitive to price.

The selection for US dollars in case of a a low pass through is primarily attributed to the relatively less fluctuative have nature of the US dollar. US dollar is considered to be a reliable currency to be priced in for a good and therefore when the importer is not willing to bring changes in the import prices, it will be pricing its imports in dollars.

When the imported is not concerned about the import prices so that even a higher pass through effect is allowed, it may be willing to price the product in non dollar currency which has a greater probability of fluctuating. This is so because even if the non dollor currency is experiencing a greater inflation more than often, it will not bother the import demand because it is highly inelastic and that is why a high pass through effect is selected for non dollar currency.