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MARKET POWER, INNOVATIVE ACTIVITY AND EXCHANGE RATE PASS-THROUGH

Sophocles N. Brissimis
Bank of Greece and University of Pireaus

Theodora S. Kosma
Athens University of Economics and Business

ABSTRACT

This paper considers an international oligopoly where firms simultaneously choose both the amount of output produced and the proportion of R&D investment to output. The model captures the links between the exchange rate, market power, innovative activity and price, which are important for the determination of the optimal degree of exchange rate pass-through. It is found that in the long run the pass-through elasticity can be less than, equal to or greater than one depending on R&D effectiveness but in any case it is higher than in models that do not endogenise innovation decisions. The empirical implications of the model are tested using data for Japanese firms exporting to the US market and applying the Johansen multivariate cointegration technique. Particular attention is given to the estimation and identification of the equilibrium price and R&D-intensity equations. The empirical results indicate that price-setting and R&D-intensity decisions of firms are jointly determined in the long run. This interdependence must be taken into account if an accurate estimate of the exchange rate pass-through is to be obtained.

Keywords: Exchange rate pass-through; market power; innovative activity; multivariate cointegration

JEL classification: C32; F39; L13; O31

Acknowledgements
We are grateful to Heather Gibson, Stephen Hall, Sarantis Kalyvitis, Thomas Moutos and Apostolis Philippopoulos for helpful comments. The views expressed in the paper are of the authors and do not necessarily reflect those of the Bank of Greece.

Address for correspondence:

Sophocles N. Brissimis,
Economic Research Department,
Bank of Greece, 21 E. Venizelos Ave.,
102 50 Athens, Greece,
Tel.: + 30 210-320 2388
Fax: + 30 210-320 2432
Email: sbrissimis@bankofgreece.gr


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