Estimation of Exchange Rate Pass-Through to Domestic Prices with Smooth Transition Autoregressive Models

Knowing the effect of the change in the exchange rate on domestic prices is very important for economies adopting the inflation targeting strategy. Due to the high use of imported intermediate goods in the production in Turkey, economic units and especially the Central Bank of Turkish Republic are closely monitoring the impact of exchange rate on prices. Therefore, the exchange rate pass-through is an issue that required to be investigated continually. In studies with using linear models, the passthrough is assumed to be symmetrical. The aim of this study is to examine the validity of Taylor’s(2000) hypothesis that low inflation rate reduces the exchange rate passthrough to prices, for Turkey by employing STR model, which is one of the nonlinear time series methods. For this purpose, monthly data for the period 2004:01-2018:07 were used. If the consumer prices inflation exceeds 7% level, exchange rate passthrough to consumer prices increases from 7,6% to 11,6%. Similarly, if the annual producer price inflation exceeds 4,4% level, exchange rate pass-through to producer prices increases from 24,1% to 37,5%. As a result, it is revealed that the exchange rate pass-through to consumer and producer prices is nonlinear according to inflation level and Taylor’s (2000) hypothesis is valid in the relevant period of Turkey.