2007): “A Framework for identifying the Sources of LocalCurrency Price Stability with an Empirical Application,” NBER Working paper No

Abstract The inertia of the local-currency prices of traded goods in the face of exchange-rate changes is a well-documented phenomenon in International Economics. This paper develops a framework for identifying the sources of local-currency price stability. The empirical approach exploits manufacturers' and retailers' first-order conditions in conjunction with detailed information on the frequency of price adjustments in response to exchange-rate changes, in order to quantify the relative importance of markup adjustment by manufacturers and retailers, local-cost non-traded components, and nominal price rigidities, in the incomplete transmission of exchange-rate changes to prices. The approach is applied to micro data from the beer market. We find that on average, approximately 53% of the incomplete exchange rate pass-through is due to local non-traded costs; 7% to markup adjustment; 18% to the existence of own-brand price adjustment costs, and 22% to the indirect/strategic effect of such costs. * We are grateful to Charles Engel for very useful conversations at an early stage of this project