Exchange Rate Pass Through of China’s Exporters

How export prices react to exchange rate shocks is one of the classic topics studied in international macroeconomics. The price of the export depends on many factors including the nominal exchange rate, the marginal cost of the product, the degree of the vertical and horizontal competition and the distribution cost. In order to get a precise estimate of the percentage changes of export prices in responds to a one percent exchange rate shock (termed as the exchange rate pass through), all other factors that influence the price should be isolated or controlled. It poses great difficulties to empirical works on estimating the exchange rate pass through as the marginal cost of an exporter is in general unobservable. The existing literature has used various proxies to control for the marginal cost. The most used two are the nominal wage index and the PPI of the exporting country. Although they may be good proxies of the average cost, they fail to capture the true marginal cost.

We offers a neat method of estimating how export prices react to exchange rate shocks by precisely controlling exporters’ marginal costs based on a comprehensive database from China customs. It utilizes the observation that most China’s exporters export their product to more than one destination. As the same product of an exporter exported to multiple destinations should have the same marginal cost, we construct a difference in difference estimator at firm-product level to eliminate the effect of the marginal cost on prices. We find significant evidence of producer currency pricing for China exporters during 2000 – 2006; the aggregate exchange rate pass through to export prices denominated in the trade partner’s currency is nearly complete (98.6%). With the proposed estimation method, this will be the first paper to our knowledge that is able to estimate and compare the distributions of the exchange rate pass through across different industries, trade modes and firm types. 

September 2015

April 2015