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short essays and reports on the economic issues of the day
2004 ■ Number 4

Import Prices and the Exchange Rate
Patricia S. Pollard
etween December 2002 and December 2003, the
dollar fell by almost 9 percent against a broad index
of currencies. Despite this decline, prices for foreign
goods sold in the United States showed little change. How
is this possible?
If we ignore transport costs, the dollar price of U.S.
imports (P $) equals the foreign currency price of these
goods (PFC) converted into dollars (e = $/foreign currency):
P$ = PFC × e. A depreciation of the dollar (increase in e)
must result in a rise in U.S. import prices, of the same magnitude, unless there is a decline in the prices foreign producers receive (PFC). The 9 percent fall in the dollar was
accompanied by only a 1 percent rise in U.S. non-petroleum
import prices, indicating that foreign producers absorbed
much of the decline in the value of the dollar. Studies have
shown that such behavior is common.
Why are changes in the exchange rate not fully passedthrough into import prices? One possibility is that changes
in import prices lag movements in the exchange rate. The
prices for goods received today were contracted at some
point in the past. If, as is typical, the prices in these contracts are invoiced in dollars, then a change in the exchange
rate may have no immediate effect on import prices. Over
time, however, firms may adjust their contract prices to
reflect the change in the foreign currency value of the dollar.
Even after accounting for such lags, U.S. import prices generally do not fully incorporate exchange rate movements.
Another possibility is that firms “price to market,”
adjusting their markup according to local market conditions. As a result pass-through may depend on the amount
of competition a firm faces in the local market, its market
share, and the extent to which its product is differentiated
from similar products. These factors are likely to vary not
only across countries but across industries. Indeed, studies
have shown that the extent to which exchange rate movements affect import prices does vary by industry.
It is also possible that firms vary their behavior depending on whether the dollar is depreciating or appreciating.


For example, a foreign firm that is attempting to increase
its share of the U.S. market may pass-through much of the
change in the exchange rate when the dollar is appreciating,
lowering the dollar price to gain market share. When the
dollar is falling, the same firm will resist passing-through
the exchange rate change in an effort to maintain the dollar
price of its product and keep its market share. Under this
strategy, U.S. import prices should fall more during an appreciation of the dollar than they rise during a depreciation.
The opposite behavior may occur if a firm is unable to
increase its sales by lowering the dollar price. For example,
a firm may face import restrictions or production bottlenecks that make it difficult to increase its sales to the United
States. As a result, the firm may keep the dollar price of its
products constant despite a rising dollar. In this case, U.S.
import prices should rise more during a depreciation of
the dollar than they fall during an appreciation.
The size of the change in the exchange rate also has an
effect on pricing behavior. If it is costly to change their
invoice prices, firms will only raise or lower prices in
response to fairly large movements in the exchange rate.
Pollard and Coughlin (2003),1 for example, found that U.S.
import prices in many industries do not respond to small
changes in the exchange rate. If, however, the dollar rises
or falls by 3 percent or more in a quarter, then import
prices will be adjusted to partially reflect the new value of
the dollar.
These considerations suggest that the link between the
exchange rate and the price of imported goods is complex,
with fluctuations affecting U.S. import prices to varying
degrees, depending on the industry. Moreover, the price
response depends on both the size and the direction of the
change in the exchange rate. More research is needed to
identify exactly how and why the prices of imported goods
react to changes in the value of the dollar. ■

Pollard, Patricia and Coughlin, Cletus. “Size Matters: Asymmetric Exchange
Rate Pass-Through at the Industry Level.” Federal Reserve Bank of St. Louis
Working Paper 2003-029B, November 2003.

Views expressed do not necessarily reflect official positions of the Federal Reserve System.