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The Exchange Rate Disconnect

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Abstract
Why do large movements in exchange rates have small effects on international goods prices? This empirical regularity is a central puzzle in international macroeconomics. In a new study, we show that the key to understanding this exchange rate disconnect is to take into account that the largest exporters are also the largest importers. This is important because when exporters import their intermediate inputs, they face offsetting exchange rate effects on their marginal costs. For example, a depreciation of the euro relative to the U.S. dollar makes exports in U.S. dollars cheaper?but it also makes imports in euros more expensive. Using Belgian firm-level data, we show that exporters that import a large share of their inputs pass on a much smaller share of the exchange rate shock to export prices. Interestingly, import-intensive firms typically have high export market shares and hence set high markups and actively move them in response to changes in marginal cost, thus providing a second channel that limits the effect of exchange rate shocks on export prices. Our results show that a small exporter with no imported inputs has a nearly complete pass-through of more than 90 percent, while a firm at the 95th percentile of both import intensity and market share distributions has a pass-through of 56 percent, with the two mechanisms playing roughly equal roles. These findings have important implications for aggregate macroeconomic variables.

Suggested Citation

  • Mary Amiti & Oleg Itskhoki & Jozef Konings, 2013. "The Exchange Rate Disconnect," Liberty Street Economics 20130211, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednls:86856
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    Cited by:

    1. Martin Berka & Michael B. Devereux & Charles Engel, 2018. "Real Exchange Rates and Sectoral Productivity in the Eurozone," American Economic Review, American Economic Association, vol. 108(6), pages 1543-1581, June.
    2. Julio Blanco & Javier Cravino, 2018. "Price Rigidities and the Relative PPP," 2018 Meeting Papers 346, Society for Economic Dynamics.
    3. Eaton, Jonathan & Kortum, Samuel & Neiman, Brent, 2016. "Obstfeld and Rogoff׳s international macro puzzles: a quantitative assessment," Journal of Economic Dynamics and Control, Elsevier, vol. 72(C), pages 5-23.
    4. Rosen Valchev, 2020. "Bond Convenience Yields and Exchange Rate Dynamics," American Economic Journal: Macroeconomics, American Economic Association, vol. 12(2), pages 124-166, April.
    5. Lasha Kavtaradze & Manouchehr Mokhtari, 2018. "Factor Models And Time†Varying Parameter Framework For Forecasting Exchange Rates And Inflation: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 32(2), pages 302-334, April.
    6. Berg, Kimberly A. & Mark, Nelson C., 2018. "Measures of global uncertainty and carry-trade excess returns," Journal of International Money and Finance, Elsevier, vol. 88(C), pages 212-227.
    7. Michael B Devereux, 2018. "Discussion of Charles Engel and Feng Zhu’s paper," BIS Papers chapters, in: Bank for International Settlements (ed.), The price, real and financial effects of exchange rates, volume 96, pages 12-18, Bank for International Settlements.
    8. Adams, Jonathan J. & Barrett, Philip, 2021. "Why are countries’ asset portfolios exposed to nominal exchange rates?," Journal of International Money and Finance, Elsevier, vol. 110(C).
    9. Berg, Kimberly A. & Mark, Nelson C., 2018. "Global macro risks in currency excess returns," Journal of Empirical Finance, Elsevier, vol. 45(C), pages 300-315.
    10. Matteo Cacciatore & Nora Traum, 2022. "Trade Flows and Fiscal Multipliers," The Review of Economics and Statistics, MIT Press, vol. 104(6), pages 1206-1223, November.
    11. Charles Engel & Feng Zhu, 2019. "Exchange rate puzzles: evidence from rigidly fixed nominal exchange rate systems," BIS Working Papers 805, Bank for International Settlements.

    More about this item

    Keywords

    pass-through entities; importers; exporters; exchange rates;
    All these keywords.

    JEL classification:

    • F00 - International Economics - - General - - - General

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