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Pass-Through of Exchange Rate Changes and Macroeconomic Shocks to Domestic Inflation in East Asian Countries

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  • Takatoshi Ito
  • Yuri N. Sasaki
  • Kiyotaka Sato

Abstract

We examine the pass-through effects of exchange rate changes on the domestic prices among the East Asian countries using the conventional pass-through equation and a VAR analysis. First, dynamics of pass-through from the exchange rate to import prices and consumer prices is analyzed using the conventional model of pass-through based on the micro-foundations of the exporter's pricing behavior. Both the short-run and long-run elasticities of the exchange rate pass-through are estimated. Second, a vector autoregression (VAR) technique is applied to the pass-through analysis. A Choleski decomposition is used to identify structural shocks and to examine the pass-through of each shock to domestic price inflation by the impulse response function and variance decomposition analyses. Both the conventional analysis and VAR analysis show that while the degree of exchange rate pass-through to import prices is quite high in the crisis-hit countries, the pass-through to CPI is generally low, with a notable exception of Indonesia. The VAR analysis shows that the size of the pass-through of monetary shocks is even larger in Indonesia. Thus, it was Indonesia's accommodative monetary policy as well as the high degree of the CPI responsiveness to exchange rates that contributed to high domestic price inflation, resulting in the loss of its export competitiveness, even when the currency depreciated sharply in nominal terms in 1997-98.

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Paper provided by Research Institute of Economy, Trade and Industry (RIETI) in its series Discussion papers with number 05020.

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Length: 55 pages
Date of creation: May 2005
Date of revision:
Handle: RePEc:eti:dpaper:05020

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  1. Feenstra, Robert C. & Kendall, Jon D., 1997. "Pass-through of exchange rates and purchasing power parity," Journal of International Economics, Elsevier, vol. 43(1-2), pages 237-261, August.
  2. Marston, Richard C., 1990. "Pricing to market in Japanese manufacturing," Journal of International Economics, Elsevier, vol. 29(3-4), pages 217-236, November.
  3. J. McCarthy, 1999. "Pass-through of exchange rates and import prices to domestic inflation in some industrialised economies," BIS Working Papers 79, Bank for International Settlements.
  4. Hahn, Elke, 2003. "Pass-through of external shocks to euro area inflation," Working Paper Series 0243, European Central Bank.
  5. Knetter, Michael M, 1989. "Price Discrimination by U.S. and German Exporters," American Economic Review, American Economic Association, vol. 79(1), pages 198-210, March.
  6. Campa, José Manuel & Goldberg, Linda S, 2004. "Exchange Rate Pass-Through into Import Prices," CEPR Discussion Papers 4391, C.E.P.R. Discussion Papers.
  7. Betts, Caroline & Devereux, Michael B., 1996. "The exchange rate in a model of pricing-to-market," European Economic Review, Elsevier, vol. 40(3-5), pages 1007-1021, April.
  8. Todd E. Clark, 1996. "The responses of prices at different stages of production to monetary policy shocks," Research Working Paper 96-12, Federal Reserve Bank of Kansas City.
  9. Michael B. Devereux & Charles Engel, 1998. "Fixed vs. Floating Exchange Rates: How Price Setting Affects the Optimal Choice of Exchange-Rate Regime," NBER Working Papers 6867, National Bureau of Economic Research, Inc.
  10. Ito, Takatoshi & Ogawa, Eiji & Sasaki, Yuri Nagataki, 1998. "How Did the Dollar Peg Fail in Asia?," Journal of the Japanese and International Economies, Elsevier, vol. 12(4), pages 256-304, December.
  11. Hamid Faruqee, 2004. "Exchange Rate Pass-Through in the Euro Area," IMF Working Papers 04/14, International Monetary Fund.
  12. Ross McLeod, 2003. "Towards improved monetary policy in Indonesia," Bulletin of Indonesian Economic Studies, Taylor & Francis Journals, vol. 39(3), pages 303-324.
  13. Sasaki, Yuri Nagataki, 2002. "Pricing-to-Market Behavior: Japanese Exports to the US, Asia, and the EU," Review of International Economics, Wiley Blackwell, vol. 10(1), pages 140-50, February.
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Cited by:
  1. Mehrotra, Aaron N., 2007. "Exchange and interest rate channels during a deflationary era--Evidence from Japan, Hong Kong and China," Journal of Comparative Economics, Elsevier, vol. 35(1), pages 188-210, March.
  2. Matthew Kofi Ocran, 2010. "Exchange Rate Pass-Through To Domestic Prices: The Case of South Africa," Prague Economic Papers, University of Economics, Prague, vol. 2010(4), pages 291-306.
  3. Carlos Cortinhas, 2007. "Exchange Rate Pass-Through in ASEAN: Implications for the Prospects of Monetary Integration in the Region," NIPE Working Papers 2/2007, NIPE - Universidade do Minho.
  4. Siok Kun, Sek, 2009. "The impacts of economic structures on the performance of simple policy rules in a small open economy," MPRA Paper 25065, University Library of Munich, Germany.

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