RDP 9304: Exchange Rate Pass-Through: The Different Responses of Importers and Exporters 7. Conclusion

This paper has reviewed the process by which changes in the exchange rate impact upon the domestic prices of traded goods. It was found that there is a long-run relationship between the exchange rate and the domestic prices of traded goods which satisfies the small country case: in the long run, over the docks, exchange rate pass-through is complete for both imports and manufactured exports. However, in the short run, there are significant differences in the response of the prices of these goods to currency movements.

It was shown that import prices over the docks respond fairly quickly to changes in the exchange rate. This was contrary to the experience of manufactured export prices, where response to exchange rate change was considerably lagged, giving rise to some degree of endogeneity in the terms of trade.

The responses of import and manufactured export prices to currency movements differed not only with respect to the speed, but to the pattern of adjustment. Tentative evidence was presented of a recent change in the way manufactured export prices respond to currency movements. Conversely, domestic import prices over the docks have exhibited a consistent pattern of response over time, even during the recent recession.

This finding of a consistent pattern of first stage pass-through to import prices has an important implication. It implies that the present environment of low inflation has not been threatened by currency depreciation because other factors have been in operation. It was proposed that the first round price effects of depreciation have been partially offset by subdued world prices. Furthermore, it was argued that these price effects are being absorbed to some extent at the second stage. In part, this is a function of the present environment of low inflation limiting the scope for alteration of the relative prices of substitutable goods. Low inflation will continue to impose an exigency in this regard. This is not to say that the retail price of imports will not rise. In fact, further pressure will come to bear on retail prices as import prices over the docks gradually move towards their long-run equilibrium. However, the extent of the rise in the retail price of imports will be inhibited by stability of the prices of related goods. Understanding the microeconomics of the second stage of price adjustment is essential for identification of the full impact of currency movement on the general price level.