Executive Summary
Exchange rate pass-through (ERPT) refers to the extent to which import prices adjust to reflect fluctuations in the exchange rate between importing and exporting countries. Complete ERPT occurs when any variation in bilateral exchange rates is perfectly mirrored in the price that importers pay in their home currency. If pass-through is incomplete, the change in the bilateral exchange rate is only partially transmitted to importer prices. The degree of ERPT is therefore of strong interest for monetary policy, as it has direct implications for domestic inflation.
However, exchange rate fluctuations, and their effect on prices, are equally important for exporters. From the exporter perspective, incomplete pass-through implies that some part of the exchange rate movement is absorbed by the exporting firm, through variation in the received unit price in their domestic currency, while complete pass-through implies that the exporter does not absorb any of the exchange rate variation.
There are a number of reasons why firms may not pass exchange rate changes through to importers, at least in the short run. Some of these reasons - pricing-to-market, menu costs, and implicit or explicit contracts with offshore customers - have direct implications for the profitability of the exporting firm. Others imply that the pressure to adjust prices in response to exchange rate fluctuations may be muted for some firms, for example through explicit exchange rate hedging or compensatory changes in the cost of imported inputs.
In this paper, we examine the extent of ERPT by New Zealand exporters, comparing pass-through behaviour across a number of dimensions: between the short run and long run, according to specific firm and product characteristics, and the invoice currency used in the export transaction.
In the short run, estimated ERPT appears to be intrinsically related to the invoice currency. Firms invoicing in the New Zealand dollar (NZD) on average adjust the New Zealand dollar prices of their goods to reflect only 9 percent of the exchange rate fluctuation, with the remaining 91 percent being passed through to the importer. In contrast, when firms invoice in the importer (local) or a third country (vehicle) currency, price rigidities in the invoice currency mean that the exporter absorbs a much greater share of the exchange rate fluctuation into their NZD-converted return.
These differences across invoice currencies generate a relationship between firm characteristics and pass-through behaviour, due to differences in invoicing practices across firms. In particular, firms with relatively high or diverse export receipts are more likely to invoice in foreign (non-NZD) currencies. As a consequence of price stickiness in the invoice currency, these firms then experience a relatively stronger impact of exchange rate fluctuations on their NZD-converted unit values. Conversely, NZD invoicing is more common among foreign-owned firms and exporters of differentiated products, leading to a milder average impact of exchange rate changes on received unit values for these groups. When currency choice is directly controlled for, firm characteristics cease to show any relationship with pass-through.
In the long run, the role of stickiness in the invoice currency weakens and NZD-denominated returns absorb a lower overall proportion of the exchange rate change. While received unit values of importer-currency pricers still respond quite strongly to the bilateral exchange rate, vehicle-currency pricers become indistinguishable from NZD pricers. Increasing pass-through to foreign prices, combined with a higher share of producer-currency invoiced observations leads to a substantial reduction in the average impact of exchange rates on received unit values in the long run. However, despite these adjustments, pass-through remains low among some groups of firms (particularly those invoicing in the local currency), suggesting that, in the absence of offsetting effects, exchange rate fluctuations affect profitability. The implied variability in export returns increases the risks associated with exporting, which may in turn reduce firms' incentives to enter and develop export markets.
