DP13085 Vehicle Currency Pricing and Exchange Rate Pass-Through

Author(s): Natalie Chen, Wanyu Chung, Dennis Novy
Publication Date: July 2018
Keyword(s): CPI, Dollar, euro, exchange rate pass-through, inflation, Invoicing, Sterling, UK, Vehicle Currency Pricing
JEL(s): F14, F31, F41
Programme Areas: International Trade and Regional Economics, International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13085

Using detailed firm-level transactions data for UK imports, this paper studies the relationship between invoicing currency choices and the response of import prices to exchange rate changes. We find that for transactions invoiced in a vehicle currency, import prices are much more sensitive to changes in the vehicle currency than in the bilateral exchange rate. Aggregate pass-through therefore substantially increases once we account for vehicle currencies. We also show how this translates into higher pass-through for UK consumer prices, in particular during the Great Recession and in the period following the Brexit referendum. Finally, we develop a theoretical framework to conceptualize exchange rate pass-through in the context of vehicle currency pricing. Overall, our results contribute to understanding the exchange rate disconnect puzzle, and have implications for the setting of monetary policy.