The microdata underlying U.S. import and export price indexes exhibit frequent product turnover and highly rigid prices. As a consequence, 40% of products are replaced before a single price change is observed and 70% are replaced after two price changes or less. An aggregate price index that focuses on price changes for identical items over time may, therefore, miss an important component of price adjustment occurring at the time of product replacements. We provide a model of this "product replacement bias" and quantify its importance using U.S. microdata on import and export prices. We show that, accounting for product replacement bias, long-run exchange rate "pass-through" into U.S. import and export price indexes is almost twice as high as conventional estimates suggest, and changes in the terms of trade are roughly 75% more volatile. Our adjustment makes pass-through statistics easier to account for with existing general equilibrium models.
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This paper was revised on December 5, 2011
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