Exchange rate pass through: the experience of the United Kingdom

The focus of the thesis is on the role of exchange rates in price setting and consequentially nominal price stickiness. A data set was constructed of individual product lines that were imported to the UK, together with competitive product lines. The empirical results showed that the impact of competitive products is significant and for one of the five products selected the pass through of exchange rates into prices was insignificantly different from zero, one passed a proportion of the exchange rate changes into price adjustments and three adjusted prices in such a way as to reinforce the exchange rate changes. A multi period pricing model was postulated, drawing on the work of Ball and Mankiw (1994) but extending it to allow exchange rates shocks to impact a firm's costs in both its home country and its export market. This model shows when temporary shocks will not be passed through and provides a rationale why permanent shocks might also not be passed through. Two further empirical studies were carried on a wider range of products. The first was conducted on imports from major trading partners of the UK. The results were based on aggregated data but showed a very similar picture to the initial product line study. The second study focused on UK exports to the same group of countries using similar products ranges to the import study. The results again showed a similar picture and further for a majority of individual countries, where there was a significant level of pass through, the sign of the exchange rate pass through changed dependent upon whether the country was importing or exporting. Indicating that a country's responsiveness to exchange rate shocks is an important determinant of firm's pricing decisions. Finally these studies provide further evidence that nominal price stickiness is evident in the UK economy