There is a sizeable empirical and theoretical literature that investigates the passthrough
of nominal exchange rate fluctuations into import prices and the resulting
change in international trade flows. Goldberg and Knetter (1997) provide a broad
review of the literature on exchange rate pass-through. Marazzi et al., (2005)
and Brun-Aguerre et al., (2012) are important recent contributions. A common
assumption in empirical studies of exchange rate pass through is that each exporter’s
entire marginal cost of product is denominated in the exporter’s domestic currency.
However, if some of the exporter’s intermediate inputs are imported, and these
costs are not denominated in the exporter’s domestic currency, then the exporter’s
marginal costs of production will only be partly exposed to fluctuations in the value of
its currency. In this more realistic case, the effect of the exchange rate changes will
depend on the share of domestic value-added in marginal costs.