The Signaling Effect of Exchange Rates: Pass-Through under Dispersed Information

Abstract

We examine exchange-rate pass-through (ERPT) to prices in a model of dispersed information in which the nominal exchange rate imperfectly conveys information about the underlying fundamentals. If the information is complete, ERPT is also complete. Under dispersed information, we derive conditions under which our model displays three properties that are consistent with the stylized facts of pass-through. First, ERPT lies between 0 and 1 (incomplete ERPT). Second, ERPT is usually higher for imported goods prices than for consumer prices (exchange rate-consumer price puzzle). Third, there is a link between ERPT and macroeconomic stability.