Vehicle Currency Pricing and Exchange Rate Pass-Through. Issue 1 (27th July 2021)

• Record Type: Journal Article
• Authors: Chen, Natalie; Chung, Wanyu; Novy, Dennis
• Is Part Of: Journal of the European Economic Association. Volume 20:Issue 1(2022)
• Page Start: 312
• Page End: 351
• Publication Date: 2021-07-27
• Subjects: Economics -- Periodicals; Économie politique -- Périodiques; Science économique; Périodique électronique (Descripteur de forme); Ressource Internet (Descripteur de forme); 330
• DOI: 10.1093/jeea/jvab025
• Languages: English
• ISSNs: 1542-4766

Abstract

Abstract: Using detailed firm-level transactions data for UK imports, we find that invoicing in a vehicle currency is pervasive, with more than half of the transactions in our sample invoiced in neither sterling nor the exporter's currency. We then study the relationship between invoicing currencies and the response of import unit values to exchange rate changes. We find that for transactions invoiced in a vehicle currency, import unit values are much more sensitive to changes in the vehicle currency than in the bilateral exchange rate. Pass-through therefore substantially increases once we account for vehicle currencies. This result helps to explain why UK inflation turned out higher than expected when sterling depreciated during the Great Recession and after the Brexit referendum. Finally, within a conceptual framework, we show why bilateral exchange rates are not suitable for capturing exchange rate pass-through under vehicle currency pricing. Overall, our results help to clarify why the literature often finds a disconnect between exchange rates and prices when vehicle currencies are not accounted for.