Structural instability in the pricing-to-market and exchange rate pass-through

Kortava, Ekaterina (2013) Structural instability in the pricing-to-market and exchange rate pass-through. PhD thesis, University of Glasgow.

Abstract

This thesis examines potential time variance of the Pricing-to-market (PTM) and Exchange rate pass-through (ERPT) from both theoretical and empirical perspectives. We argue that the response of the export and import prices to the exchange rate is time dependent. We develop three models that justify the inconstancy of the PTM and ERPT. The first model represents a partial equilibrium theoretic framework where the existence of the cost of switching between substitutes generates structural breaks in the ERPT parameters. This model is subsequently tested by applying the threshold regression framework of Hansen (1999) to data on the US imports from selected European economies. The second model is a partial equilibrium model of export pricing where consumers dislike price volatility. Through solving the firm’s profit maximization problem we show that the volatility of the exchange rate undermines the stability of the response of the export price to currency movements. This model is tested using data on the UK exports to the EU and four out-of-sample forecasting tests, namely fixed, rolling, recursive and random walk coefficient time varying parameter regressions. The third model represents a dynamic stochastic general equilibrium model with subsistence points in consumption and investment. It features two countries and two types of firm – local currency pricing and producer currency pricing. Through maximizing the household’s utility and firms’ profits we show that the extent of the PTM and ERPT is time varying and depends on the unstable response of the mark-up of price over the marginal cost to currency movements. In order to illustrate the inconstancy of the mark-up for both firm types, we compute the impulse responses of the mark-ups to positive shocks to consumer preferences and production technology. Our findings on the time variance of the PTM and ERPT have important policy implications. Since the degree of the PTM and ERPT into import prices affects the extent of the rise of the domestic price level following the devaluation of the domestic currency, monetary policy should consider potential time evolution of the PTM and ERPT in order to control inflation.

• Item Type: Thesis (PhD)
• Qualification Level: Doctoral
• Keywords: Pricing-to-market, exchange rate pass-through, local currency price stability
• Subjects: H Social Sciences > HB Economic Theory; H Social Sciences > HG Finance
• Colleges/Schools: College of Social Sciences > Adam Smith Business School > Economics
• Supervisor's Name: MacDonald, Professor Ronald and Byrne, Professor Joseph
• Date of Award: 2013
• Depositing User: Dr Ekaterina Kortava
• Unique ID: glathesis:2013-4787
• Copyright: Copyright of this thesis is held by the author.
• Date Deposited: 27 Feb 2014 14:17
• Last Modified: 27 Feb 2014 14:19
• URI: https://theses.gla.ac.uk/id/eprint/4787