Abstract: We explore the negative balance sheet effect of foreign currency borrowing on the exchange rate pass-through to domestic prices. Exploiting a large unexpected devaluation episode in Korea in 1997, we show that firms with higher foreign currency debt have indeed experienced balance sheet deterioration and faced lower growth rates of sales and net worths and reduced their price-cost markups. We then empirically document that a sector populated by firms with higher foreign currency debt exposure prior to the crisis experienced a larger price increase. Building a heterogeneous firm model with financial constraints, we quantify the role of foreign currency liabilities in explaining the exchange rate pass-through to prices and find that 20% to 80% of the sectoral price changes during the crisis can be explained by the balance sheet effect of foreign currency debt alone. We emphasize the role of strategic complementarity in amplifying the sectoral price increase.
Presented at: Midwest Macro Fall 2019, Korea International Economic Association 2022 Winter Conference at SNU, ASSA Meeting 2023, Ohio State University, Yonsei University, University of Seoul, NBER East Asian Seminar on Economics 2023, Washington Area International Finance Symposium, 3rd WE_ARE_IN Macroeconomics and Finance 2023, 4th Women in International Economics Conference, Johns Hopkins University - Economics Department, ASSA Meeting 2024, NBER International Finance and Macroeconomics Program Meeting Spring 2024, WE_ARE Virtual Seminar Series, University of Houston, Southern Economic Association 2024, Waseda University, Keio University
First version: August 2019
