Liability Dollarization and Exchange Rate Pass-Through To Domestic Prices
Description
We explore the negative balance sheet effect of foreign currency borrowing on the exchange rate pass-through to domestic prices. Exploiting a large, unexpected depreciation episode in Korea in 1997, we show that firms with higher foreign currency debt experience balance sheet deterioration and face lower growth rates of net worth, sales, and markups. We then empirically document that sectors populated by firms with higher foreign currency debt exposure prior to the depreciation exhibit larger price increases. Building a heterogeneous-firm model with financial constraints, we quantify the role of foreign currency debt in explaining the exchange rate pass-through to prices and find that 10% to 44% of sectoral price changes during the depreciation episode can be explained by the balance sheet effect of foreign currency debt alone. We emphasize the role of strategic complementarity in amplifying sectoral price increases.
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Institutions
- Johns Hopkins University School of Advanced International StudiesDistrict of Columbia, Washington
- Korea Development InstituteSeoul, Seoul