The Effect of Firm-Level Productivity on Exchange Rate Pass-Through

Abstract

A heterogeneous-firm trade model can explain the recent decrease in exchange rate pass-through to aggregate U.S. import prices as a result of decreased trade costs. A decrease in trade costs enables lower-productivity firms to begin exporting. The recent decrease in the responsiveness of U.S. import prices to exchange rates can be explained by the entry of these new exporters. This paper finds support for this explanation by testing another implication of this type of heterogeneous firm model: lower exchange rate pass-through for goods that are traded for short periods of time. This model also predicts that low-productivity firms have more volatile markups.

Keywords: Heterogeneous firms, exchange rate pass-through

JEL Classification: F12, F31, F41