The Scope for Exchange Rate Pass-through in an Oligopoly

This paper represents one of the first analyses of exchange rate pass-through in a dynamic context. It explores the impact of exchange rate fluctuations in a duopoly where firms interact over an indefinite period of time. In these circumstances there exists an incentive for the duopolists to tacitly collude. The paper investigates the manner in which exchange rate changes influence the inherent tension that exists between the incentives to collude and compete. It is shown that the sign and degree of exchange rate pass-through depends critically upon: the expected duration of a change in the exchange rate and the relative competitive strengths of the firms. The predictions of the model closely accord with the empirical evidence on exchange rate pass-through.