Exchange-rate pass-through (ERPT) is a measure of how responsive international prices are to changes in

exchange rate In finance, an exchange rate is the rate at which one currency will be exchanged for another currency. Currencies are most commonly national currencies, but may be sub-national as in the case of Hong Kong or supra-national as in the case of ...

s. Formally, exchange-rate pass-through is the

elasticity Elasticity often refers to: *Elasticity (physics), continuum mechanics of bodies that deform reversibly under stress Elasticity may also refer to: Information technology * Elasticity (data store), the flexibility of the data model and the cl ...

of local-currency import prices with respect to the local-currency price of foreign currency. It is often measured as the

percentage change In any quantitative science, the terms relative change and relative difference are used to compare two quantities while taking into account the "sizes" of the things being compared, i.e. dividing by a ''standard'' or ''reference'' or ''starting'' va ...

, in the local currency, of import prices resulting from a one percent change in the exchange rate between the exporting and importing countries. A change in import prices affects

retail Retail is the sale of goods and services to consumers, in contrast to wholesaling, which is sale to business or institutional customers. A retailer purchases goods in large quantities from manufacturers, directly or through a wholesaler, and t ...

and consumer prices. When exchange-rate pass-through is greater, there is more transmission of

inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reductio ...

between countries. (2002

NBER Working Paper The National Bureau of Economic Research (NBER) is an American private nonprofit research organization "committed to undertaking and disseminating unbiased economic research among public policymakers, business professionals, and the academic c ...

version, ) Exchange-rate pass-through is also related to the law of one price and

purchasing power parity Purchasing power parity (PPP) is the measurement of prices in different countries that uses the prices of specific goods to compare the absolute purchasing power of the countries' currency, currencies. PPP is effectively the ratio of the price of ...

Example

Suppose that the US imports widgets from the UK. The widgets cost $10 and £1 costs $1. Then the British Pound appreciates against the dollar and now £1 costs $1.50. Also suppose that the widgets now cost $12.5 There has been a 50% change in the exchange rate and a 25% change in price. The exchange rate pass-through is :

\frac=.5.

For every 1% increase in the exchange rate, there has been a .5% increase in the price of the widgets.

Measurement

The "standard pass-through regression" is :

\Delta \ln p_ = \alpha+\sum_^N\gamma_i \Delta \ln e_+\delta \Delta \ln c_t+ \psi\Delta \ln d_t +\epsilon_t,

where

p

is import price,

e

is the exchange rate,

c

is marginal costs,

d

is demand, and

\Delta

denotes a first difference. The exchange-rate pass-through after

N

periods is :

\sum_^N\gamma_i.

Campa and Goldberg (2005) estimated the long-run exchange-rate pass-through to import prices for the following countries, averaging across the countries from which imports came: Measurement of exchange-rate pass-through is typically performed using aggregate price indexes. Some studies have examined how firms in different industries or with different production costs differ in their responses to exchange rates. Studies of firm-level differences explain why exchange-rate pass-through is not equal to one and how globalization caused a decrease in exchange-rate pass-through.{{cite journal , doi=10.1016/j.econlet.2013.10.028 , last1= Cook , first1 = J.A., year= 2014 , title = The Effect of Firm-Level Productivity on Exchange Rate Pass-Through , journal = Economics Letters , volume=122 , issue=1, pages = 27–30, doi-access= free

References

Foreign exchange market