Exchange rate pass-through and product heterogeneity: does quality matter on the import side?

Using Italian firm-level data for the period 2000-2006, this paper investigates the role of the quality of imported inputs and exported output in determining the heterogeneous response of exporters' prices to real exchange rate fluctuations. The analysis confirms previous findings that the imports of intermediate inputs and the quality of the exported output increase an exporter's ability to reduce the exchange rate pass-through into the prices perceived by foreign consumers. Our novel finding is that the `intermediate imports channel' has a weaker negative impact on the exchange rate pass-through into the price of higher quality exported varieties. The paper shows that this finding is consistent with the predictions of a model where both the suppliers of high quality intermediate inputs and the exporters of high quality final goods follow pricing strategies that offset exchange rate variations.