Imperfect Exchange Rate Passthrough: Strategic Pricing and Menu Costs

Abstract

A large body of literature finds that exporters do not pass nominal exchange rate movements fully through to destination market prices over short time horizons. This imperfect passthrough has been widely attributed to strategic “pricing-to-market”, whereby exporters deliberately accept changes in the home currency value of export prices in order to gain or defend market share. We show that imperfect passthrough in the short run may also arise from simple menu costs. In contrast to strategic pricing, however, the long run passthrough is complete under menu costs — with associated implications for trade adjustment. Examining the cover prices of two magazines, The Economist and Business Week, we find support for menu costs as a partial explanation of imperfect passthrough.