Working Paper: CEPR ID: DP3710
Authors: Giancarlo Corsetti; Luca Dedola
Abstract: This Paper builds a baseline two-country model of real and monetary transmission in the presence of optimal international price discrimination by firms. Distributing traded goods to consumers requires non-tradables, intensive in local labour. Because of distributive trade the price elasticity of demand depends on country-specific shocks to productivity and the exchange rate. Hence, within limits dictated by the possibility of arbitrage, profit-maximizing monopolistic firms drive a wedge between prices across countries at both wholesale and retail level. Optimal pricing thus results in possibly large deviations from the law of one price and incomplete pass-through on import prices. Consistent with the received wisdom on international transmission, nominal and real depreciations worsens the terms of trade. In general, the nominal and real exchange rate are more volatile than fundamentals, and large movements in the international prices translate into small changes in consumption, employment and the price level. Finally, we provide an example showing that international policy cooperation may be redundant even when asset trading is ruled out, despite incomplete pass-through and less than optimal risk sharing.
Keywords: exchange rate; pass-through; international cooperation; nominal rigidities; wholesale and retail prices
JEL Codes: F30; F40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| deviations from the law of one price (F31) | prices across countries (P22) |
| optimal pricing by monopolistic firms (D42) | deviations from the law of one price (F31) |
| optimal international price discrimination (D40) | incomplete exchange rate pass-through (F31) |
| nominal exchange rate changes (F31) | import prices (P22) |
| nominal depreciations (G32) | terms of trade (F14) |
| nominal exchange rates (F31) | price volatility (G13) |
| real exchange rates (F31) | price volatility (G13) |
| monetary rules targeting domestic output gap (E61) | international policy cooperation (F55) |