Which would raise the exchange-rate pass-through?

Question

BlackTom AI · Accepted Answer

Exchange-rate pass-through (ERPT) measures how much a change in the exchange rate changes the domestic-currency price of goods. A key determinant is the currency in which contracts and costs are denominated: whether prices and input costs are invoiced in a foreign currency or in the domestic currency shapes how exchange-rate moves feed into domestic prices.

Relevant knowledge points and concepts
- ERPT: fraction of an exchange-rate change that is reflected in domestic prices.
- Currency invoicing: when prices/costs are denominated in a foreign currency, exchange-rate moves mechanically change the domestic-currency price; when denominated in domestic currency, exporters/importers may absorb exchange movements to preserve market shares.
- Pricing-to-market/market-preservation: firms concerned with keeping market share often absorb exchange-rate shocks, reducing pass-through.
- Distributional costs (domestic-markup, transport, retail margins): large domestic-cost shares dilute the exchange-rate component of final prices, lowering ERPT.

Step-by-step reasoning
1. If fewer prices and costs are denominated in foreign currency (i.e., a smaller share is invoiced in foreign currency), more of pricing and costs are set in domestic currency. Firms then cannot simply keep foreign-currency prices fixed to shield domestic prices from currency moves; domestic-currency price adjustments become the channel through which exchange-rate changes are accommodated.
2. With prices/costs mainly in domestic currency, an exchange-rate depreciation raises the domestic cost of any foreign inputs and pressures margins; firms respond by raising domestic-currency retail prices rather than maintaining foreign-currency price levels. This increases the measured ERPT.
3. Conversely, when a large share of prices/costs are invoiced in foreign currency, a currency movement can be absorbed in the importer’s or exporter’s accounts (or show up directly as an unchanged foreign-currency price), reducing the motivation or need to change domestic-currency retail prices — lowering pass-through.

Illustrative (conceptual) calculation
- Suppose an imported good’s foreign-currency price is fixed at 100 FC. If the exchange rate goes from 1 DC/FC to 1.2 DC/FC, the domestic price rises from 100 DC to 120 DC (100% pass-through of the FX move into the domestic price).
- If instead the good is invoiced and contracted in domestic currency (100 DC), the exporter/importer may absorb the FX change and keep the domestic price at 100 DC (0% pass-through). Moving toward more domestic-currency denominated pricing therefore increases the sensitivity of domestic prices to exchange-rate changes when firms adjust margins — raising measured ERPT.

Why the correct option is correct
- “Less prices and costs are denoted in foreign currencies” increases the degree to which domestic prices must adjust to exchange-rate moves, so it raises ERPT.

Why the other options are incorrect
- “Higher share of distributional costs”: Distributional (domestic) costs are paid in domestic currency and dilute the exchange-rate-sensitive share of the final price, lowering ERPT rather than raising it.
- “More concern with market preservation”: Firms preserving market share tend to absorb exchange-rate shocks in margins instead of raising prices, reducing pass-through.
- “All of these”: Because the other two listed factors reduce pass-through, this choice is incorrect.

Conclusion
Given the role of invoicing currency and how domestic vs. foreign currency denomination affects price adjustment incentives, the option “less prices and costs are denoted in foreign currencies” is the factor that would raise exchange-rate pass-through, matching the provided answer.

Which would raise the exchange-rate pass-through?Single choice

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