Working Paper: CEPR ID: DP3608
Authors: Michael B. Devereux; Charles M. Engel; Peter E. Storgaard
Abstract: This Paper develops a model of endogenous exchange rate pass-through within an open economy macroeconomic framework, where both pass-through and the exchange rate are simultaneously determined, and interact with one another. Pass-through is endogenous because firms choose the currency in which they set their export prices. There is a unique equilibrium rate of pass-through under the condition that exchange rate volatility rises as the degree of pass-through falls. We show that the relationship between exchange rate volatility and economic structure may be substantially affected by the presence of endogenous pass-through. Our key results show that pass-through is related to the relative stability of monetary policy. Countries with relatively low volatility of money growth will have relatively low rates of exchange rate pass-through, while countries with relatively high volatility of money growth will have relatively high pass-through rates.
Keywords: exchange rate passthrough; monetary policy; sticky prices
JEL Codes: F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| exchange rate volatility (F31) | passthrough rates (G19) |
| monetary growth volatility (O42) | passthrough rates (G19) |
| exchange rate volatility (F31) | monetary growth volatility (O42) |
| monetary policy stability (E63) | passthrough rates (G19) |