This paper assesses whether partial exchange rate pass-through to trade prices has important implications for the prospective adjustment of global external imbalances. To address this question, we develop and estimate an open-economy DGE model in which pass-through is incomplete due to the presence of local currency pricing, distribution services, and a variable demand elasticity that leads to fluctuations in optimal markups. We find that the overall magnitude of trade adjustment is similar in a low and high pass-through world with more adjustment in a low pass-through world occurring through a larger response of the exchange rate and terms of trade rather than real trade flows.
About the Authors
Sylvain Leduc is executive vice president and director of Economic Research at the Federal Reserve Bank of San Francisco. Learn more about Sylvain Leduc