[This paper shows that temporary exchange rate fluctuations can have persistent (i.e., hysteretic) effects on trade prices and quantities. Specifically, if market-entry costs are sunk, sufficiently large real exchange rate shocks can alter domestic market structure and thereby induce hysteresis. This simple idea idea has strong implications for exchange rate theory, trade policy, and the estimation of trade equations. Empirical evidence suggests that the recent dollar overaluation induced hysteris in U.S. import prices.]

This paper shows that temporary real exchange rate fluctuations can have persistent (hysteretic) effects on trade. Specifically, when market-entry costs are sunk, sufficiently large exchange rate shocks alter domestic market structure and thereby induce hysteresis. This simple result has strong implications for exchange rate theory, t rade policy, and estimation of trade equations. Empirical evidence su ggests that the recent dollar overvaluation induced hysteresis in U.S. import prices. Namely, the aggregate pass-through equation (of exchange rates to import prices) shifted in the 1980s. The shift's nature and timing is broadly consistent with the hysteresis hypothesis.