Download International Macroeconomics and Finance Session 6-7

International Macroeconomics and Finance
Session 6-7
Nicolas Coeurdacier - [email protected]
Master EPP - Fall 2011
Session 7 - Real exchange rates and purchasing power parity - Part 2
• Exchange-rate pass through and pricing to market
Exchange rate pass-through and pricing to market
Deviations from PPP can come also from:
- Imperfect transmission of changes of nominal exchange rates to prices (imperfect pass-through)
- Currency invoicing decisions : Producer versus Local Currency Pricing
- Differences in mark-ups in different countries for a given good: Pricing to
Market (PTM).
Note: local currency pricing implies some pricing to market but PTM can have different origins
(marketing, costs differences, different elasticity of demand).
Exchange rate pass-through
Motivation
From 2002 to 2007, US $ has depreciated by almost 30% against basket of
major currencies: how much inflation does this imply for the US (via increased
import prices)?
Depends on how much of the falling value of US currency is passed through to
import prices and then to consumer prices.
Important consequences for inflation but also for the impact of monetary policy:
in Mundell Fleming/Dornbush model typical 100% pass-through is assumed
(exchange rate changes affect exports and real activity through expenditure
switching).
Exchange rate pass-through
Motivation
Debates on how exchange rate changes affect adjustment of global imbalances
depend on how exchange rates affect prices and quantities: if small effect
of exchange rates on import prices, on consumer prices then small effect on
demand, exports, and current account?
Link with question of modelling nominal rigidities in an open economy: are
prices rigid in the currency of the exporter or the importer?
Producer Currency Pricing (PCP)
Home country H is importer. Exporters from Foreign country F set prices
in their own currency (PF∗ : price of of foreign good sold in F , expressed in
foreign currency) and let prices abroad (PFH =price of of foreign good sold in
H, expressed in home currency=import price for H) move one-to-one with the
exchange rate S (domestic currency per unit of foreign currency):
Import price = PFH = SPF∗
There is one-to-one pass-through of exchange rate movements onto the price
of imports, at both the border and the consumer-price level. Hence, once
measured in the same currency, goods prices are identical in all markets: the
law of one price holds.
Local currency pricing (LCP)
Home country H is importer. Suppose now firms set a price on the export
markets that may be different from the price on their domestic market. They
set this price in the currency of the importer H = PFH .
Hence ‘Local Currency Pricing’ (LCP):
PFH is now potentially different from different from SPF∗ . Suppose PFH is rigid
(preset in advance) and S moves.
Then, changes in exchange rates did not affect import prices for H. Exchange
rate pass-through on import prices is zero at both the border- and the consumerprice level. The law of one price is violated anytime the exchange rate fluctuates
unexpectedly.
⇒No effect of exchange rates on consumer prices, demand and exports!
Imperfect Pass-Through
The changes in import prices compared to changes in exchange rate can be
anything between these two values [1 under PCP and 0 under LCP and rigid
prices].
The exchange rate pass-through (EP T ) denotes the ratio between %change
in import prices and %change in nominal exchange rate
With our notations:
%∆PFH
EP T =
%∆S
Imperfect Pass-Through
Example:
In 2002, the price in Germany of a Golf is P€ = 15000€ and the price of the
same Golf in the US is P$ = 15000$. In 2002, the spot rate (S) is 1€/$. Over
the period 2002-2004, the euro appreciates by 25%. Price of a Golf in the US
was fixed at 17250$ in 2004. Exchange rate pass-through over this two years
period?
P$(2004) = 17250$, then prices have increased by 15%. The pass-through is
then 15/25 = 60%
60% of the exchange rate variations were reflected in foreign prices.
Note that under perfect pass-through: P$(2004)=S(2004) ∗ 15000 = 1.25 ∗
15000 = 18750$
Real exchange rate movements are large but small effect on prices and
quantities?
Part of the "disconnect puzzle"
1) incomplete pass-through of ER movements into import prices: Campa and
Golberg (2005), OECD: 50% after 1 quarter; 64% after 1 year
2) Exchange rate changes have little effect on agregate quantities (exports):
Typical macro elasticities are around 1 or just above: much lower than elasticities suggested in trade literature
Correlation between exchange rate movement and inflation not very strong (in
the short-run): Example UK 1993-1994 (ERM crisis): Pound depreciates by
15% but inflation only 2%. What happens to consumer prices of imported
goods when exchange rate depreciates? Macro and micro evidence point to low
pass-through
Exchange rate pass-through: evidence
See Campa and Goldberg (2005): import price of a country (for a specific
good) can be written as a transformation of export price of foreign country (in
foreign currency):
P mj = SP xj
Export prices depend on a markup over marginal costs. In log terms (small
letters):
pmj = s+mkupxj +mcxj
The markup itself may depend on sectoral characteristics and may react to
exchange rate (see later):
mkupxj = α + Φs
The marginal costs of the exporter depend on exporter wages and destination
market conditions:
mcxj = γy + δwx
so:pmj = α + (1 + Φ)s + γy + δwx
Pass-through measured by: β = 1 + Φ
Φ = 0 : producer currency pricing, 100% pass-through
Φ = −1: local currency pricing, 0 pass-through (exporters absorb exchange
rate movements in their markup and their producer prices)
Test: Use quarterly data on import price indices (23 OECD countries): 19752003
To allow for gradual adjustment of import prices test in first differences:
mj
∆pt
−4
−4
j
j
j
j
j
j
j
= α + β i ∆st−i + δi ∆wt−i + γ i ∆gdpt + ut
i=0
i=0
j
Short run (one quarter) elasticity: β 0
−4
Long run (one year) elasticity:
β ji
i=0
estimated with OLS
elasticities of ER Pass-through into agg. import prices
short run long run
France
.53∗+
.98∗
Germany
.55∗+
.80∗
Italy
.35∗+
.35+
Japan
.43∗+
1.13∗
Netherlands .79∗+
.84∗
UK
.36∗+
.46∗+
US
.23∗+
.42∗+
Average (23) .46
.64
*+ : elasticity
= 0, 1 at 5% level
Note low US pass-through; LCP rejected in most countries in SR and LR; PCP
rejected also in SR but less in LR (7 out of 23 countries); Some evidence that
pass-through has fallen over time
Also investigate if lower pass-through for firms producing more differentiated
products. Idea that these firms adjust mark-ups more (consistent with theory,
see later).
Do find such sectoral differences.
Lower pass-through in manufacturing (average across countries of 0.43 in short
term and 0.62 in long run) compared to other sectors (energy, raw material,
non-manufacturing...) where pass-through is around 0.6/0.7 in short run and
0.8 in long run.
Micro-evidence: Gopinath and Rigobon (2008) and Gopinath, Itskhoki
and Rigobon (2009)
Micro data a the product level on import and export prices collected by the
Bureau of Labor Statistics for the United States: 1994-2005.
1) prices are sticky in the currency in which they are reported as priced.
Average price duration for market transactions = 10.6 months for imports and
12.8 months for exports (wholesale prices at the border)
Prices of manufactured goods much more sticky than primary products. Evidence of price stickiness at the US border.
2) Local currency pricing for U.S. imports and producer currency pricing for
U.S. exports
Close to 90% of U.S. imports and 97% of U.S. exports are priced in dollars.
So local currency pricing for imports and producer currency pricing for exports:
Asymmetry in terms of which country bears the risk of exchange rate movements.
3) trend decline in the probability of price adjustment for imports
The average probability of price change has declined by 10 percentage points
from 1994 to 2004. But not much coming from composition effect (more trade
in differentiated goods) as in Campa and Goldberg
4) exchange rate pass-through into U.S. imports even conditioning on a price
change is low when LCP (imports priced in dollars). Very high if PCP.
If imports priced in dollars (LCP):
Even conditioning on a price change, trade weighted exchange rate pass-through
into U.S. import prices is low, at 24%: estimate pass-through conditional on
an observed price change (= standard lag specification used in aggregate regressions). Measure pass-through as the change in prices in response to the
cumulative change in the exchange rate since it last changed its price.
If imports are priced in foreign currency (PCP)
Conditioning on a price change, pass-through is still close to unity (95%).
Gopinath, Itskhoki and Rigobon (2009): conditioning on price changes
1) Standard pass-through equation; monthly aggregate data
∆pk,t = αi +
n
n
3
j=0
j=0
j=0
β j ∆ek,t−j +
γ j πk,t−j +
δj ∆yt−j + ǫk,t
Gopinath, Itskhoki and Rigobon (2009): conditioning on price changes
2) What happens when one conditions on price change?
Good level estimations:
−
′ γ+ǫ
∆ p i,t = [β D Di + β N D (1 − Di)] ∆cei,t + Zi,t
i,t
−
∆ p i,t : change in log dollar price conditional on price adjustment in the currency
of pricing
∆cei,t: cumulative change in the log of bilateral exchange rate over duration
of previous price
Di =dummy equals 1 if good i prices in dollars
Gopinath, Itskhoki and Rigobon (2009): conditioning on price changes
Implications?
Low pass-through not only about price stickiness together with LCP.
Develop a model of endogenous currency choice and optimal pass-through.
Idea? LCP implies low pass-through if price stickiness. But firms do not
have much higher pass-through when changing prices. Choose LCP when long
run desired pass-through is low (desired pass-through depends in particular on
imported inputs, curvature of demand...).
Imperfect pass-through and Pricing to Market: Theory
Main mechanism:
Pricing to market can be generated in any model where depreciation of exporter’s currency lowers the perceived elasticity of demand of exporters (not
standard CES with constant mark-ups).
Class of models with heterogeneous and variable elasticity of demand (and
mark ups): elasticity of demand decreases with productivity and real currency
depreciation.
Basically more productive (and bigger) firms have lower demand elasticity (and
higher mark-ups) and when facing a depreciation they increase mark-ups even
more ⇒ low pass through
Imperfect pass-through and Pricing to Market: Theory
- Melitz Ottaviano (2008): linear demand functions; price elasticity of demand
↑ with consumer price: depreciation means lower relative costs, lower consumer
price, lower demand elasticity: exporters react by increasing markup
Plus: high productivity firms have a lower demand elasticity to start with. RER
depreciation leads to increase in mark-ups (as demand elasticity even smaller)
but even more so for high productivity firms.
Imperfect pass-through and Pricing to Market: Theory
- Atkeson and Burstein (2009): imperfect competition (Cournot).
Firms with a higher market share (high performance firms) face a lower demand
elasticity and have higher mark-ups.
Depreciation increases market share of exporters in destination market =⇒
lower even more demand elasticity =⇒ ↑ mark-ups
Mark up response larger for larger (more productive) firm.
Imperfect pass-through and Pricing to Market: Theory
- Corsetti and Dedola (2007): local additive distribution costs (ηiwi) :.
pci ≡ psi τ i + ηiwi
i
A share of the consumer price is not a affected by RER, this implies a low
perceived elasticity of demand (and higher mark ups). The more so for high
productivity firrms (lower pi)
With depreciation (si ↑) a smaller share of final consumer price depends on
exporter price, lowers the perceived elasticity of demand to export prices =⇒
increase markup
Same mechanism for firms productivity: higher productivity firms have lower
demand elasticity to start with ⇒ higher prod. firms do more pricing to market
(absorb more exchange rate movements in their markups)
Imperfect pass-through and Pricing to Market: Theory
Key mechanism in these papers: a depreciation lowers the price elasticity of demand so mark-up increases with depreciation: exporters react to a depreciation
by increasing their price in domestic currency and do not pass-through entirely
the depreciation to foreign consumers.
And even more so for high performance firms.
High performance (productivity) firms choose to increase their producer price
(increase mark-ups) following a depreciation and not their exported volumes.
The reverse for low performance firms.
Mechanism tested in Berman, Martin and Mayer (forthcoming).
Berman, Martin and Mayer (forthcoming)
Motivation
Real exchange rate movements are large but seem to have small effects on:
- (Import) prices: very low pass-through as seen above. Even when conditioning
on a price change.
- Quantities: Exchange rate changes have little effect on aggregate volume of
exports. Typical macro elasticities are around 1 or just above.
This paper focuses on heterogeneous responses of exporters to RER changes.
Main result: High performance exporting firms increase significantly more their
(producer) price and significantly less their quantities following a RER depreciation
- For the average exporter: 10% depreciation of the RER leads 1% (resp. 5%)
increase in price (resp. volume)
- A standard-deviation increase in firm’s performance raises the price elasticity
to 2%, and decrease the volume elasticity to 3.5%
Only firms with performance above the median increase their prices following
an RER depreciation. Results hold for various indicators of performance
Aggregate implications:
if exports are concentrated on a small number of high performance firms, low
aggregate response to RER changes
Empirically find that sectors in which exporters are more heterogeneous indeed
react less to RER
Reproduce their results in a model of heterogeneous pricing to market following
Corsetti and Dedola (2007) [see paper]
Empirics
Data: Large database on French firms. 2 sources:
1) French customs for firm-level trade data: export, for each firm, by destinationyear, both in value and volume;
2) Firm-level information from INSEE: sales, employment, sector...
Merge the two: virtually all individual French exporters still present (90%)
Period: 1995 to 2005
Export unit values:
Testable implication (1):
The elasticity of the producer price, pi to a real depreciation (an increase in
RERi) is positive and increases with the productivity of the firm denoted ϕh
(and more generally export performance)
Firm h exporting to i : Log(Unithit) = αpLog(ϕht−1) + β pLog(RERit) +
γ pLog(ϕht−1) × Log(RERit) + ψ t + µhi + ǫhit
RERit:average RER between France and i during year t.
Testable implication 1: Price response larger for high performance firms: interaction term γ p > 0
Testable implication (2)
The elasticity of the firm exports (volume x) to a real depreciation (increase in
RERi) is positive and decreases with the productivity of the firm denoted ϕh
Firm h exporting to i : Log(xhit) = αv Log(ϕht−1) + β v Log(RERit) +
γ v Log(ϕht−1) × Log(RERit) + δZit + ψ t + µhi + ǫhit
Testable implication 1: Volume response lower for high performance firms:
interaction term γ v < 0