PASS-THROUGH OF COMPETITORS’ EXCHANGE RATES 15 Table 3. Pass-through of competitors’ RERs (model) <!-- Start of picture text --> A. US+10 Foreign Country PE B. 3 Country Symmetric PE<br>Dependent Import Prices US Producer Pr Import Prices US Producer Pr<br>Variable:<br>(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)<br>Bilateral RER 0.65 0.63 0.62 0.75 0.71 0.70<br>Competitors’ RER 0.15 0.09 0.11 0.13<br>Foreign Comp. 0.19 0.11 0.14 0.15<br>Prices<br>Note: coefficients from regressions of simulated producer/import prices on simulated RERs.<br>Firm−level bilateral pass−through (Sampled by size) Firm−level competitors pass−through (Sampled by size)<br>1 0.45<br>Firm 2: Many<br>0.4 foreign competitors<br>0.9<br>0.35<br>0.8<br>0.3<br>0.7 0.25<br>0.6 0.2<br>0.15<br>0.5<br>0.1<br>0.4<br>0.05 Firm 1: Few Foreign<br>competitors<br>0<br>0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7<br>Firm sector share Firm sector share<br>Pass−through of own bilateral exchange rate Pass−through of competitors exchange rate<br><!-- End of picture text --> Figure 2. Bilateral βBI (LHS) and competitors’ PT βC (RHS) by firm size (3 country model) The “average”β ̃C is around 0.1,bilateral pass-through coefficientalmost identical to the corresponding βBI is around 0.7 and the average competitors’ PT coefficientestimates in Column (7) of Table 3.

From Figure 2, one can see that all small firms have high bilateral pass-through and low competitors’ ER pass-through. On average, large firms tend to have lower bilateral pass-through, and higher pass-through of competitors’ exchange rates, though there is substantial variation in both βBI and βc, depending on whether firms face competitors from foreign competitor countries vs from compatriots/US firms. Consider two firms with sector share ≈ 0.45 in the RHS of Figure 2. Firm 1 happens to have very little competition from firms in the foreign country in the same sector and so β<sup> ̃</sup> C ≈ 0. In contrast, firm 2 has a large share of foreign competitors and so is very sensitive to competitors’ exchange rates (β<sup> ̃</sup> c ≈ 0.44).

5.2. **The bias in measured bilateral PT and the correlation of RERs.** How important is the correlation of exchange rates for bilateral pass-through? As shown in Equation 5, there will be omitted variable bias if competitors’ exchange rates are excluded from the estimated equation in the data. The effect of omitted variable bias depends on the correlation between competitors’ RERs and the bilateral exchange rate. Due to the presence of common shocks in the US (for example, a US TFP shock), bilateral and competitors’ exchange rates will generally be positively correlated. This suggests that measured univariate bilateral pass-through will generally be upward biased, as in Testable Prediction 2.

Figure 3 shows how the omitted variable bias from excluding competitors’ RERs varies with the correlation of the two RERs (US-Foreign Country 1 and US-Foreign Country 2) in the three-country model. The black solid line is measured bilateral pass-through from a univariate regression of simulated import prices on the bilateral RER, as is common in the literature. The red dashed line represents “true” bilateral pass-through