Are Import Prices More Elastic To Local Currency Depreciations Than Appreciations?

Abstract

Exchange rates and international prices are endogenous – exchange rates influence export prices directly through the costs of intermediate imports, but import price inflation feeds back into the exchange rates indirectly through monetary policy. This paper shows how to quantify the causal effect of exchange rate movements on international prices by imposing micro-founded identification restrictions derived from an estimated multi-country business cycle model. It further tests whether exchange rate transmission into import prices is non-linear by replicating the observed higher-order moments of OECD export price inflation and wage growth in reduced form. The model predicts that US import prices at the border are on average 11% more elastic to USD depreciations than appreciations – the skewness of OECD export price inflation is transmitted through widespread participation in Global Value Chains (GVC). Consequently, if monetary authorities of OECD economies were equally averse to inflation and deflation, USD appreciations would not deteriorate the US trade balance by as much as it would improve when the USD depreciates.