Trade liberalisation and import price behaviour: the case of textiles and wearing apparels

Previous studies on the relationship between exchange rates and traded goods prices typically find evidence of incomplete pass-through, usually explained by pricing-to-market behaviour. Although economic theory predicts that incomplete pass-through may also be linked to presence of non-tariff barriers to trade, variables reflecting such a link is rarely included in existing empirical models. In this paper, we estimate a pricing-to-market model for Norwegian import prices on textiles and wearing apparels, controlling explicitly for the removal of non-tariff barriers to trade and the shift in imports from high-cost to low-cost countries through a Törnqvist price index based measure of foreign prices. We show that this measure of foreign prices unlike standard measures used in the literature is likely to produce unbiased estimates of the degree of pass-through, and thereby also the extent of pricing-to-market behaviour. Finally, we demonstrate that the estimated import price equation is reasonably stable and exhibits no serious forecasting failures. These findings contradict the hypothesis that pass-through has changed alongside trade policy shifts during the second half of the 1990s and the monetary policy regime shift in 2001.