International Review of Economics and Finance 19 (2010) 1–2

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International Review of Economics and Finance

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Introduction

Exchange rate pass-through and exchange rate dynamics

The present section on Exchange rate pass-through and exchange rate dynamics brings together papers on exchange rate pass-through and on the joint dynamics of international payments and exchange rates. These topics are analyzed from new andinteresting perspectives in a variety of developed, transition and emerging market economies, and important policy conclusionsare derived.

The extent to which exchange rate variations are passed through along the price chain has been the subject of intensetheoretical and empirical research during the last two decades. The main reason is that exchange rate pass-through (ERPT) hasimportant micro and macroeconomic policy implications. In the microeconomic sphere, the extent of ERPT to prices of tradablegoods reveals the pricing strategies of foreign exporting firms. Thus, zero ERPT to import prices is usually due to local currencypricing—or pricing to market—behaviour of foreign firms. In that case, exporting firms set prices in the currency of the importingcountry, such that the adjustment to nominal exchange rate variations is borne by the prices in the currency of the exportingcountry andmark-ups of the exporters. Firms act as price takers in the currency of the importer country. On the contrary, completeERPT to import prices results from producer currency pricing, according to which prices expressed in the currency of the exportercountry do not react to exchange rate variations, and mark-ups of the exporting firms remain constant. The latter case describeswell the situation in which exporting firms have market power, and importers are price takers in international markets.

ERPT has two broad macroeconomic implications. First, it determines the impact of exchange rate movements on the internalrate of inflation and, consequently, the degree towhich exchange rate fluctuations interferewith themain task of the central banks.Second, since the rate of ERPT may vary considerably across price indices, it may affect the real exchange rate. This is extremelyrelevant to assess whether devaluation may be used to absorb external shocks.

It is not then surprising that the magnitude of ERPT has been widely investigated for different countries and institutionalcontexts. The first generation of empirical works—prior to the 1980s—used aggregate data, considering ERPT as a macroeconomicphenomenon. During the 1980s and 1990s, studies with macroeconomic focus have shared the field of analysis with other micro-based approaches. Results for high-income countries tend to point out that: a) exchange rate variations have a small impact onexport prices, which reveals some market power of the exporting firms, and impinge relatively large ERPT upon tradable prices ofthe importing countries; b) ERPT shows a decreasing trend in more recent years; c) ERPT decreases along the pricing chain.

Recently, there is a growing ERPT literature trying to ascertain whether the three above mentioned features also apply toemerging market economies, and which are the main determinants of the extent of ERPT in those countries. In general, findingsgo in the same direction as those previously obtained for developed countries or they follow even more intensively.

The four articles on ERPT presented in the special section of this issue explore new and interesting ERPT issues for countrieswith very different levels of economic development.

Yushi Yoshida focuses on the ERPT to export prices in a developed country (Japan), and includes two important novelties withrespect to previous studies. First, the author investigates ERPT to the prices of exports originating in five Japanese ports, whichenables him to analyze whether ERPT is homogeneous across regions within the same country. Second, he uses monthly data fromJanuary 1988 to December 2005 that is more disaggregated than that used in most studies of ERPT (HS 9-digit level). Panel dataregressions that control for exporting industry and for importing country provide strong evidence that export prices are set atdifferent levels across local ports and that they react differently to fluctuations in the exchange rate.

Sushanta Mallick and Helena Marques undertake sectoral disaggregated analysis of ERPT to the prices of the India's exportsdenominated in the currencies of the importer countries. The authors use panel data of 2-digit SITC sectors at both monthly andannual frequencies, and apply cointegration for heterogeneous panels in order to uncover the role of data frequency in determiningvariation in the degree of short and long-run ERPT. Their results indicate that: 1) The pass-through of changes in the rupeeexchange rate into export prices is generally incomplete or imperfect since 1991, especially in themanufacturing sector; 2) ERPT todestination market prices turns out to be more incomplete with monthly data than with annual data, which is a natural result ifaccount is taken that the annual frequency erodes most of the short run rigidities; 3) In the long run, incomplete ERPT subsists in

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2 Introduction

the industries that represent a higher share of exports, for both data frequencies, implying that the impact has been sector-specific;4) Incomplete pass-through to export prices in India has been favoured by the extensive reforms (trade liberalization and thereplacement of a managed float by a free float exchange rate regime) undertaken in this country since 1991.

Ramón María-Dolores investigates ERPT to import prices of some new member states (NMSs) of the European Union plusTurkey, for imports of these countries coming from the euro area. He performs a disaggregated analysis (1-digit SITC level) in orderto assess the differences in ERPT among nine different product categories. He analyses short run and long-run ERPT elasticities andobtains very heterogeneous results for both industries and countries. His findings support the regularity observed in high-incomecountries, according to which ERPT declines along the pricing chain, and also confirm that lower ERPT elasticities go hand in handwith lower rates of domestic inflation (Taylor's hypothesis).

José García-Solanes and Fernando Torrejón-Flores shift towards the macroeconomic dimension of ERPT and choose emergingmarket economies (EMEs) as the focus of their investigation. Their main objective is to evaluate the extent to which someeconomic and institutional factors, inherent to risky and indebted EMEs, affect the pass-through generated by currencydevaluation in those countries. To perform their task, the authors build a structural stochastic model for a small open developingeconomy. Simulation analysis shows that balance-sheet effects created by capital market imperfections and the home bias shrinkthe impact of devaluation on both producer and consumer internal prices, but not the impact on import prices. This finding helpsexplaining why ERPT to internal general prices is low in EMEs. It also shows that, for benchmark values of the parameters,devaluation remains a good device tomodify the real exchange rate and tomitigate the negative impact of external shocks in EMEs.

Finally, Nikolas A. Muller-Plantenberg analyzes the relationship between balance of payments imbalances and the dynamics ofexchange rates in open economies. The author builds and simulates several models of international adjustment that reflectdifferent assumptions on capital controls, the nature of capital flows—autonomous or accommodating—and the exchange ratesystem—fixed, flexible or managed. The predictions of the model regarding the joint movements of the current account, thefinancial account and the exchange rate are borne out by the economic performance of major industrial countries during the lastfour decades as well as by the experiences of countries that were hit by currency crises in the past or have used crawling pegs toavoid such crises.

Acknowledgements

We thank the participants in the 7th INFER workshop on International Economics, organised jointly by INFER (InternationalNetwork For Economic Research) and AEEFI (Spanish Association of International Economics and Finance), and held at theUniversity of Murcia in March 2008, for their very useful comments on previous versions of the papers. A special word of thanksgoes to the guest speakers (Hamid Beladi, Daniel Bernhofen and Paul De Grauwe) for sharing their insights in the parallel sessions.We are also grateful to all the anonymous referees for their careful reviewing, which allowed the papers to take their current form.Finally, we acknowledge the financial contribution by Caja Murcia.

Helena MarquesManchester Business School, University of Manchester, Booth Street West, Manchester, M15 6PB, UK

⁎Corresponding author.E-mail address: Helena.Marques@mbs.ac.uk.

José García-SolanesDepartamento de Fundamentos del Análisis Económico, Facultad de Economía y Empresa, University of Murcia,

Campus de Espinardo, 30100 Murcia, SpainE-mail address: solanes@um.es.