Exchange Rate Pass‐through to Trade Prices: The Role of Nonlinearities and Asymmetries^*

TLDR

Exchange rate pass‑through is commonly assumed to be linear and symmetric. This study tests these assumptions for export and import prices in the G7 economies. The authors augment a standard linear model with polynomial functions of the exchange rate and interactive dummy variables to capture nonlinearities in profit‑margin reactions that may arise from price rigidities and switching costs. Results show that nonlinearities and especially asymmetries matter, though their magnitude differs across countries.

Abstract

Abstract A standard assumption in the empirical literature is that exchange rate pass‐through is both linear and symmetric. This study tests these assumptions for export and import prices in the G7 economies. It focuses on non‐linearities in the reaction of profit margins to exchange rate movements, which may arise from the presence of price rigidities and switching costs. Nonlinearities are characterized by augmenting a standard linear model with polynomial functions of the exchange rate and with interactive dummy variables. The results suggest that nonlinearities and especially asymmetries cannot be ignored, although their magnitude varies noticeably across countries.