Does the exchange rate pass-through into prices change when inflation targeting is adopted? The Peruvian case study between 1994 and 2007

Abstract

pe (G. Rodriguez). 1 Throughout this paper the concept of exchange rate pass-through into prices (import, producer, or consumer prices) makes reference to the exchange rate variations' effect over the variations of the respective price index, provided that the former is due to an exchange rate shock. When the price index is not specified, it must be understood that the paper is referring to the exchange rate pass-through into the consumer prices. Journal of Macroeconomicsj o u r n a l h o m e p a g e : w w w . e l s e v i e r . c o m / l o c a t e / j m a c r oopen economies -such as Peru's -given that changes in the pass-through can affect both inflation forecasts and the effectiveness of monetary policy.Throughout this paper, the pass-through is regarded as a nonlinear phenomenon that depends, in particular, on the monetary policy scheme. Although, to the authors' knowledge, a comprehensive theory explaining how the monetary policy scheme conditions the magnitude of the pass-through does not exist, several papers are reviewed to shed light on this relationship. For this purpose, a dynamic stochastic general equilibrium model (DSGEM) -calibrated for a small open economy -is simulated. It is shown that when the central bank adopts IT, it becomes less responsive to exchange rate fluctuations, thus allowing for increased exchange rate volatility. This result is particularly relevant given that the theory of the currency denomination of international trade predicts that an increase in the exchange rate variance induces a decrease of the share of firms that set their prices in foreign currency. Finally, by using a formal definition for the passthrough, it is shown that the latter is directly dependent on this share. Consequently, it is concluded that adopting IT reduces the pass-through.In the empirical literature, Gagnon and Ihrig (2004) are amongst the first to suggest that decreased pass-throughs, observed in several countries, can be attributed to a greater commitment and credibility of central banks in maintaining low levels of inflation. Although they do not make an explicit connection between the greater commitment and credibility of central banks and IT, it is clear that these characteristics are fundamental to the implementation of this scheme. In their paper, they estimate the pass-through for 20 countries (7 of which adopted IT) for two subsamples: one with high inflation and another with low inflation. It is worth mentioning that the cut date that separates both sub-samples does not coincide with the adoption date of IT (in the case of the countries that adopted this regime). The results of Gagnon and Ihrig (2004), which are drawn from a uni-equational linear model, show that the pass-through decreased in most countries. Furthermore, although IT countries had, on average, a greater pass-through in the high inflation subsample, the result is reversed in the low inflation scenario. Finally, by means of instrumental variables, they estimate Taylor rules for all the countries considered and show that pass-thr...

Effects of a mandatory local currency pricing law on the exchange rate pass-through

“…The results are robust to two different events that took place alongside the enactment of the Law: the IT adoption and the broader de-dollarization process. First, while there is prior evidence that the IT regime is associated with a lower ERPT at the aggregate level (Maertens et al, 2012;Winkelried, 2014), we find that the Law played a key role in reducing the ERPT for a specific set of goods at the disaggregate level. These results may point to some degree of complementarity between both policies: the IT regime played a role in reducing the ERPT at the macro level, while the Law on local currency pricing had the largest impact in diminishing the ERPT at the micro level, particularly for A.2 Non-dollarized prices and imported content…”

“…For example, the 2002-2017 year-end 12-month inflation average was 2.8 percent, lower than the 1992-2001 average of 15.3 percent. 25 The previous works that study the impact of the IT adoption on the ERPT in Peru are Maertens et al (2012) and Winkelried (2014). Both use the aggregate CPI and time series methodologies and find that the ERPT falls after implementation of the IT, because of the lower exchange rate uncertainty associated with the IT.…”

“…Perez Forero and Vega (2015) observe a non-linear 1-year accumulated ERPT of approximately 20 percent for depreciations and 10 percent for appreciations. Maertens et al (2012) analyze how the ERPT interacts with the inflation targeting (IT) regime. They find that once the IT regime was adopted, the 1-year ERPT for the CPI fell from 30 percent to 0 percent, while the long-run ERPT fell from 43 percent to 6 percent.…”

Analysis of Symmetric and Asymmetric Effects of Exchange Rate Pass-Through in Inflation-Targeting Countries

“…The Dornbusch-Overshooting Model explains that differences between short-run and long-run exchange rates and price deviations from the equilibrium point in the short-run cause changes in the inflation rate. The research that found differences in the amount of exchange rate pass-through in countries that adopted inflation-targeting policies was Odria et al (2012); Shintani et al (2013); Dilla (2014); Anh et al (2018); Pham et al (2020); . This study uses data from middle-income countries (South Africa, Brazil, India, Indonesia, and Mexico) and high-income countries (Australia, Canada, Japan, Norway, and Sweden).…”

Pass-through del tipo de cambio en América Latina

“…El presente estudio toma de muestra a Colombia, Chile, México y Perú. Precisamente, a partir del año 2003, dichas economías comienzan a coincidir con un nuevo régimen monetario, el cual ha generado mayor estabilidad y reducción del traspaso (Sansone y Justel, 2015;Mujica, 2015;Maertens et al 2012;Winkelried, 2011).…”