Exchange rate pass-through and inflation: A nonlinear time series analysis

Abstract

JEL Classification: C22 E31 F31 a b s t r a c t This paper investigates the relationship between the exchange rate pass-through (ERPT) and inflation by estimating a nonlinear time series model. Based on a simple theoretical model of ERPT determination, we show that the dynamics of ERPT can be well approximated by a class of smooth transition autoregressive (STAR) models using the past inflation rate as a transition variable. We employ several U-shaped transition functions in the estimation of the time-varying ERPT to US domestic prices. The estimation result suggests that declines in the ERPT during the 1980s and 1990s are associated with lowered inflation.

Recent estimates of exchange rate pass-through to import prices in the euro area

“…24 In a new strand of literature, some empirical studies gave a supportive evidence of a nonlinear connection between pass-through and inflation regime (see e.g. Ben Cheikh and Louhichi, 2014; Shintani et al, 2013). Finally, we can explore another potential determinant of ERPT which is the degree of openness of a country.…”

Market Entries and Exits and the Nonlinear Behaviour of the Exchange Rate Pass-Through into Import Prices

“…Price inertia arising from menu cost provide one explanation for this incomplete pass-through effect. Al-Abri and Goodwin (2009) and Shintani et al (2013) have recently argued, and confirmed with empirical evidence, that this should introduce nonlinearities in the pass-through with respect to the level of inflation.…”

“…As depicted in the top left panel of Figure 1, with averages of the quarter-to-quarter change of the GDP Deflator of 0.4 per cent and a maximum value of 2.3 per cent since the beginning of the 1980s, this has lead to a high degree of price stability. This is important since Shintani et al (2013) have shown that, rather than swings in the exchange rate, a time-varying ERPT can also be an artefact of changing levels of inflation. Secondly, as a small economy that is open to international trade, imports account for around 1 /3 of Swiss GDP implying that an exchange rate induced shift in the volume of imports could have noticeable price effects.…”

“…For the sake of brevity, these results are not reported here, but are available on request. Secondly, Shintani et al (2013) have suggested that differences in the ERPT are an artefact of varying levels of inflation. However, the GDP deflator depicted in the top right panel of Figure 1 did not significantly affect the regime switching probability whilst the coefficient estimates for the ERPT remained by and large unchanged.…”

“…Though it has long been recognised that, with sticky prices, different levels of inflation can give rise to differences in the ERPT between countries (e.g. Taylor, 2000;Gagnon and Ihrig, 2004;Campa and Goldberg, 2005;Choudhri and Hakura, 2006;Frankel et al, 2012), only recently, Al-Abri and Goodwin (2009) as well as Shintani et al (2013) have suggested that this might warrant nonlinear models to estimate the nexus between import prices and exchange rates. Arguably, when menu cost create a threshold delineating when an adjustment of import prices is worthwhile, the ERPT of a given country could vary between periods with low and high inflation.…”