Staff Reports

A Structural Approach to Identifying the Sources of Local Currency Price Stability

Previous title: “A Framework for Identifying the Sources of Local Currency Price Stability with an EmpiricalApplication”
June 2007Number 287
Revised February 2012
JEL classification: F0, D4, L1

Authors: Pinelopi Koujianou Goldberg and RebeccaHellerstein

The inertia of the local-currency prices of traded goods in the face of exchange-rate changes is a well-documented phenomenon in international economics. This paper develops a structural model to identify the sources of this local-currency price stability and applies it to microdata from the beer market. The empirical procedure exploits manufacturers' and retailers’ first-order conditions in conjunction with detailed information on the frequency of price adjustments following exchange-rate changes to quantify the relative importance of local nontraded cost components, markup adjustment by manufacturers and retailers, and nominal price rigidities in the incomplete transmission of such changes to prices. We find that, on average, approximately 60percent of the incomplete exchange rate pass-through is due to local nontraded costs, 8percent to markup adjustment, 30percent to the existence of own-brand price adjustment costs, and 1percent to the indirect/strategic effect of such costs, though these results vary considerably across individual brands according to their market shares.

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