Trade sensitivity to exchange rates in the context of intra-industry trade,” IMF Working Paper

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper theoretically and empirically investigates export sensitivity to exchange rates in the context of intra-industry trade (IIT). It is assumed that more IIT implies a smaller elasticity of substitution among differentiated products and vice versa. The model presented suggests the gap in production costs between two countries has an influence on IIT as well. Industry-level panel regressions of thirty-eight trading pairs provide strong empirical support for the idea that the exchange rate sensitivity of exports declines in concert with the extent of IIT. An obvious policy implication is that the effectiveness of exchange rates in addressing trade imbalances will diminish as the extent of IIT increases