A 1997 spike, a definition, and a 10 percent example

Theoretical and empirical work on the subject, the notes write, has been carried on, with the United States at its center, from the 1970s up to the recent years of the notes themselves. They define exchange-rate pass-through as the degree to which export or import prices change when the exchange rate moves. During the IMF period, which they place in 1997, the dollar–won rate rose sharply, as far as 2,000 won. In an economy highly dependent on trade abroad, that unusual increase was seen as having a large effect on major macroeconomic variables such as prices, interest rates, employment, and wages.

If the won–dollar rate falls 10 percent — that is, if the won rises in value — and Korean exporters raise the dollar price of a car they sell in the United States by 10 percent, the notes write, the change in the rate can be seen as having been passed fully, 100 percent, into price. In reality, they add, it is common not to pass a change in the rate fully into the local price, because of competition with other countries’ goods, among other reasons. A traditional view in the field is that a firm with a high market share has more market power, and therefore more room to pass the rate through; an analysis they cite, however, found that the degree of pass-through was not large among exporters with a high share. That result, they write, suggests that a lower exchange-rate sensitivity in some export items, such as electronics, is not simply the fruit of better quality or a stronger brand.

Price discrimination, pricing to market, and a finding on volatility

Price discrimination, they write, is the practice of setting different prices for the same good in markets that are apart in place or in time. The economic reason is that the price elasticity of demand differs across a few clearly distinct markets: a relatively low price is set where elasticity is relatively high, and a relatively high price where elasticity is lower. A geographic difference in price — which can, in some cases, amount to dumping — includes the gap between home and foreign selling prices for durable consumer goods such as cars; a difference in time includes, for example, a night discount on an electricity tariff. For discrimination to hold, the markets must be clearly separated, and the cost of reselling a good from one market to another must be larger than the gap in price. A firm’s strategy of setting different prices by market is, they add, easily explained if one assumes a representative monopolist with market power in a given industry. Among the empirical models they name is a pricing-to-market model of just this kind of differentiated pricing, together with a model for estimating pass-through. A student discount at a theatre or a cinema, they note, can also be read as a difference in price across markets that are apart in age.

After the foreign-exchange crisis, they write, a free-floating exchange-rate system was put in place, capital was liberalized at speed, and swings in the won widened greatly. Empirically, a one-unit widening of exchange-rate volatility lowered the growth of export volume by 0.12 to 0.17 percentage points. By item, a negative effect was estimated for information and communications, home appliances, machinery, chemicals, and light-industry goods — mainly, they judge, because profitability was relatively low, or because the firms were small and weak at absorbing foreign-exchange risk. Semiconductors and automobiles, they write, weaken that influence through high profitability or a multinational character, which makes them better at absorbing the risk; steel and petroleum products weaken it because they depend heavily on imported raw materials, so that a change in export margins is offset, to some degree, on the import side. Most Korean export goods also compete in world markets with goods from Japan, China, and other major countries, and frequent adjustments to the export price may weaken consumers’ trust, so that even when volatility widens, it is not easy to pass it into the export unit price.

A word on purchasing-power parity, and tools for the money supply

Taken together, the notes conclude, a country as dependent on exports as Korea needs to work so that exchange-rate volatility does not widen too far. Above all, they write, it is important to broaden the base of the foreign-exchange market, whose scale of trading remains limited relative to the degree of capital liberalization. In the traditional theory of purchasing-power parity, each country’s inflation rate is a long-run factor in the exchange rate: if home inflation runs higher than abroad, export competitiveness weakens, import demand rises, the current account worsens, and the home currency is pushed down. Realized inflation works through the relative prices of traded goods, and through the current account, with a lag; a change in expected inflation, or an unexpected rise in prices, can move the rate at once through the asset market, as participants sell the home currency in anticipation of a weaker current account or of weaker confidence.

Among the causes of an increase in the money supply they list three tools. Open-market operations are a way for the central bank to add to, or to reduce, funds in the market by buying or selling government bonds — Treasuries in the United States, and, in Korea, government bonds or monetary-stabilization securities. The central bank may also lower or raise the interest rate at which it lends to banks, a rate they call the discount rate, in order to increase or reduce the money supply; and it may set required reserves against a bank’s non-interest-bearing assets lower or higher. Of the three, they write, a change in the discount rate was, in the recent practice they describe, the method most often used. Open-market operations they treat as a temporary policy tied to a change in the cycle, and a change in the reserve-requirement rate, they add, does not, empirically, produce a large change in market interest rates through the supply and demand for money. Those tools, and the 0.12 to 0.17 figure, remain in the notes’ own window, not as later official totals. The same Korean report, at fuller length, is on CampusDown.

Sources

1. The notes’ account of exchange-rate pass-through and pricing to market, including the 1997 spike toward 2,000 won and the 0.12 to 0.17 percentage-point finding

Last updated: 14 November 2026