Inflation and exchange rate pass-through

This paper investigates exchange rate pass-through into consumer prices by considering the nature of the shock triggering currency movements. By individually estimating structural factor-augmented vector autoregression models for 55 countries, monetary policy shocks are shown to be associated with higher exchange rate pass-through measures compared to other domestic shocks, while global shocks have widely different effects across countries. Pass-through measures tend to be lower in countries that combine flexible exchange rate regimes and credible inflation targets, where central bank independence can greatly facilitate the task of stabilizing inflation by using the exchange rate as a buffer against external shocks. It is implied that exchange rate pass-through should be investigated by considering the nature of the shock that triggers currency movements and country characteristics that affect the response of prices.