The effect of firm-level productivity on exchange rate pass-through

•A decrease in trade costs changes the composition of exporters.•This change in exporters can explain why exchange rate pass-through is decreasing.•This study finds evidence in support of this explanation.•This letter finds that lower-productivity firms have lower exchange rate pass-through.

A heterogeneous-firm trade model can explain the recent decrease in exchange rate pass-through to aggregate US import prices as a result of decreased trade costs. This paper finds support for this explanation by testing another implication of this type of heterogeneous firm model: lower exchange rate pass-through for goods that are traded for short periods of time.