Exchange Rate Shocks and the Speed of Trade Price Adjustment

A quantity adjustment cost model is developed in the context of international trade along the lines proposed by Krugman (1987). The model implies that prices adjust dynamically to exchange rate fluctuations. The price adjustment speed is determined as a function of foreign demand responsiveness, the appropriate discount rate, and an adjustment cost parameter. Pass‐through is incomplete and increases over time and with the speed of price adjustment. A preliminary empirical analysis finds that the speed of price adjustment from the time series by industry and then in a cross‐sectional regression tentatively relates the obtained adjustment speeds to their theoretical determinants.