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.
Gust, Christopher J., Nathan Sheets, and Sylvain Leduc. 2008. “The Adjustment of Global External Balances: Does Partial Exchange Rate Pass-Through to Trade Prices Matter?,” Federal Reserve Bank of San Francisco Working Paper 2008-16. Available at https://doi.org/10.24148/wp2008-16