Global value chain participation and exchange rate pass-through

This paper draws a causal link between the rise of global value chain participation and the decline of exchange rate pass-through to import prices over the last decades. We first present a structural two-country model in order to illustrate how participation in global value chains can impact exchange rate pass-through to import prices. In the model, the sensitivity of an economy's domestic-currency production costs to exchange rate changes rises as it participates more in global value chains by importing a larger share of its intermediate inputs. The increased sensitivity of the economy's domestic-currency production costs to exchange rate changes translates into a higher sensitivity of its domestic-currency export prices. The latter implies a reduction of the sensitivity of the economy's foreign-currency export prices