Effects of a mandatory local currency pricing law on the exchange rate pass-through

Paper produced as part of the BIS Consultative Council for the Americas Research Network project "Exchange rates: key drivers and effects on inflation and trade"

Summary

Focus

This paper discusses whether Law 28300 of 2004, which required Peruvian firms to express their prices in the Peruvian currency in a context of high price dollarisation, affected the exchange rate pass-through (ERPT).

Contribution

The paper is the first study of the impact on the ERPT of the 2004 law on local currency pricing, whose enactment represents a unique natural experiment. 

Findings

Using disaggregated consumer price index data and price dollarisation data obtained from local newspapers, we find that, after the law was enacted, the ERPT fell for goods and services with dollarised prices, albeit to varying degrees depending on the type of good or service.

Abstract

This paper discusses whether Law 28300 of 2004, that required Peruvian firms to express their prices in Peru's currency in a context of high price dollarization, affected the exchange rate pass-through (ERPT). We hypothesize that the enactment of the Law introduced menu costs for firms that used to set their prices in dollars, prompting several of them to make a permanent switch to pricing in local currency. Using disaggregated consumer price index (CPI) data, we find that, following passage of the Law, the ERPT was completely offset for non-durable goods with dollarized prices, and partially offset for durable goods with dollarized prices. These effects may vary due to differences in imported component shares, market power, and markup pricing. 

JEL classification: D04, D49

Keywords: exchange-rate pass through, price dollarization, local currency pricing