Exchange Rate Pass-through, Firm Heterogeneity and Product Quality: A Theoretical Analysis

Zhi Yu
2013 Federal Reserve Bank of Dallas, Globalization and Monetary Policy Institute Working Papers  
This paper theoretically explores how exchange rate pass-through depends on firm heterogeneity in productivity and product differentiation in quality. Using an extended version of the Melitz and Ottaviano (2008) model, I show that exporting firms absorb exchange rate changes by adjusting both their markups and product quality, which leads to an incomplete exchange rate pass-through. Moreover, the absolute value of exchange rate absorption elasticity (the percentage change in the export prices
more » ... the export prices denominated in the currency of the exporting country in response to a one percent change in the exchange rate rate) negatively depends on firm productivity for products with high scope for quality differentiation, but positively depends on firm productivity for products with low scope for quality differentiation.
doi:10.24149/gwp141 fatcat:mdex64gvm5gorjjryshefywckq