Monetary shocks, exchange rates, and the extensive margin of exports

• This paper studies the real exchange rate and the extensive margin of exports.
• An open economy Dynamic General Equilibrium model with sticky-prices is developed.
• Exchange rate pass-through to consumer prices affects export participation.
• A favorable movement in the real exchange rate expands the extensive margin.
• The results are consistent with firm-level empirical studies.

This paper develops a two-country Dynamic General Equilibrium model to assess the relationship between the real exchange rate and the extensive margin of exports. Exchange rate pass-through to consumer prices governs the relative strength of a demand channel onto the exporting decision of a firm. With incomplete pass-through, a favorable movement in the real exchange rate generates increased export participation and an expansion in the extensive margin of exports. This result is consistent with firm-level studies, and contributes to an ongoing empirical debate as to the importance of changes in export participation over the business cycle.