Essays in International Macroeconomics

Abstract

How do exchange rates and tariffs shape the economy? Their effects both independently and in regard to each other are puzzling with respect to classical economic models. This dissertation focuses on how macroeconomic factors -- sticky prices (Chapter 1), interest rates (Chapter 2), and scale economies (Chapter 3) -- inform the scope of exchange rates and tariffs. Unveiling these factors helps illuminate the nature of these shocks' influence.

Chapter 1: The first chapter revisits the classic relationship between exchange rate pass-through, how exchange rates influence prices, and expenditure-switching, the resulting substitution between home and foreign goods. Expenditure-switching is the main channel through which exchange rates transmit to the real economy. Conventional wisdom holds that this channel's strength is increasing in exchange rate pass-through into prices: assuming the import demand elasticity is independent of pass-through, larger effects of exchange rates on prices yield larger substitution of spending between domestic and foreign goods. In this paper, I show that this conventional wisdom does not hold. Using confidential US micro-data and a panel-data local projection technique, I show that quantity-exchange rate elasticities are similar across high and low pass-through environments. In essence, low pass-through is subject to a larger import demand elasticity than is high pass-through. I then propose an extension of a standard small open economy New Keynesian model by adding a layer of import buying (retail) firms, in which both exporting and importing firms are subject to price rigidities. I show empirically and theoretically that the ``import buyer rigidity" dampens overall adjustment, but less so under low pass-through because in this case the pass-through is more persistent. The model thus accounts for why the quantity-exchange rate elasticities are similar across pricing regimes. I conclude by exploring the implications of this framework for monetary and exchange rate policy, actually finding a stronger expenditure-switching channel under low pass-through.

Chapter 2: The second chapter, joint with Victor Orestes, documents how currency markets and trade flows respond to tariffs imposed by and on the US as related to other countries' macrofinancial position. We show that countries which maintain higher interest rates than the US depreciate much more strongly -- to the point of offsetting the tariffs on impact -- than their low-interest counterparts. However, these effects are not as persistent as the tariff shocks. Our results highlight a US hegemonic asymmetry: tariffs imposed on the US have little effect on currency markets, US demand for high-interest countries' goods is relatively elastic, but the latter's demand for US exports is not. Monetary policy can be an effective tool to target the exchange rate fluctuation as it has a similar incidence as tariffs. Finally, we present evidence that the interest rate analysis could draw from trade-network fundamentals. To rationalize our findings, we modify a baseline model of exchange rate determination using the interest rate as a "sufficient statistic" wedge in fundamentals. Our model indicates that the financial market imperfections we observe in data distort the global response to tariff escalation.

Chapter 3: The third chapter proposes an answer to the question of why there is complete long-run pass-through of both tariffs and exchange rates in US exports, despite evidence of flexible markups. I develop a methodology to leverage tariffs and exchange rates to uncover the structural drivers of pass-through, the markup elasticity and the marginal cost scale elasticity. I derive and quantify the scale channel of pass-through, which can be decomposed into a bilateral scale and the novel "shock span" scale effect. The shock span channel arises because different correlation patterns across customers enters prices via the scale channel. Because exchange rates are correlated across trading partners, compared to tariffs they have greater capacity for shock-span effects of scale economies. Quantifying the bilateral and shock span components of the scale channel, the paper demonstrates that scale economies can rationalize the discrepancy between markup flexibility and observed pass-through.