DP15019 Currency appreciation, distance to border and price changes: Evidence from Swiss retail prices

Author(s): Reto Foellmi, Adrian Jäggi, Fabian Schnell
Publication Date: July 2020
Keyword(s): Distance to Border, Exchange rate, Price Setting Behavior of Firms
JEL(s): E30, E31
Programme Areas: International Macroeconomics and Finance, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15019

How does the exchange rate affect the way that firms adjust their prices? We use quarterly firm and product price data, underlying the Swiss sectoral consumer price index. The data allows us to trace the pricing decisions of the identified firm over time and as a function of the distance to the border distance. The appreciation of the Swiss franc results in an increase in the probability of both positive and negative price changes. When a firm is more closely located to the border, the probability of a negative price change is higher. On the intensive margin, we document that an appreciation of the Swiss Franc leads to price reductions, and that this effect is stronger the closer a firm is located to the nearest border. However, for firms located far away from the border, an appreciation of the Swiss Franc leads to no price reductions or even increases. We rationalise this by the relative strengths of income and substitution effects. The substitution effect dominates for firms close to the border, while the income effect dominates for firms located further away from the border.