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Exchange Rate Pass-Through to Consumer Prices: The Increasing Role of Energy Prices

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  • Hyeongwoo Kim
  • Ying Lin
  • Henry Thompson

Abstract

A group of researchers has asserted that the rate of exchange rate pass-through (ERPT) to domestic prices has declined substantially over the last few decades. We revisit this claim of a downward trend in ERPT to the Consumer Price Index (CPI) in a vector autoregressive (VAR) model for US macroeconomic data under the current floating exchange rate regime. Our VAR approach nests the conventional single equation method, revealing very weak evidence of ERPT during the pre-1990 era, but statistically significant evidence of ERPT during the post-1990 era, sharply contrasting with previous findings. After statistically confirming a structural break in ERPT to total CPI via Hansen's (2001) test procedure, we seek the source of the structural break with disaggregated level CPIs, pinning down a key role of energy prices in the break. The dependency of US energy consumption on imports increased since the 1990s until the recent recession. This change magnifies effects of the exchange rate shocks on domestic energy prices, resulting in greater responses of the total CPI via this energy price channel.

Suggested Citation

  • Hyeongwoo Kim & Ying Lin & Henry Thompson, 2019. "Exchange Rate Pass-Through to Consumer Prices: The Increasing Role of Energy Prices," Auburn Economics Working Paper Series auwp2019-01, Department of Economics, Auburn University.
  • Handle: RePEc:abn:wpaper:auwp2019-01
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    File URL: https://cla.auburn.edu/econwp/Archives/2019/2019-01.pdf
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    References listed on IDEAS

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    1. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
    2. Takhtamanova, Yelena F., 2010. "Understanding changes in exchange rate pass-through," Journal of Macroeconomics, Elsevier, vol. 32(4), pages 1118-1130, December.
    3. Jeffrey Frankel & David Parsley & Shang-Jin Wei, 2012. "Slow Pass-through Around the World: A New Import for Developing Countries?," Open Economies Review, Springer, vol. 23(2), pages 213-251, April.
    4. Hansen, Bruce E, 1997. "Approximate Asymptotic P Values for Structural-Change Tests," Journal of Business & Economic Statistics, American Statistical Association, vol. 15(1), pages 60-67, January.
    5. Hansen, Bruce E., 2000. "Testing for structural change in conditional models," Journal of Econometrics, Elsevier, vol. 97(1), pages 93-115, July.
    6. Andrews, Donald W K, 1993. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Econometrica, Econometric Society, vol. 61(4), pages 821-856, July.
    7. Jonathan McCarthy, 2007. "Pass-Through of Exchange Rates and Import Prices to Domestic Inflation in Some Industrialized Economies," Eastern Economic Journal, Eastern Economic Association, vol. 33(4), pages 511-537, Fall.
    8. Andrews, Donald W K & Ploberger, Werner, 1994. "Optimal Tests When a Nuisance Parameter Is Present Only under the Alternative," Econometrica, Econometric Society, vol. 62(6), pages 1383-1414, November.
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    More about this item

    Keywords

    Exchange Rate Pass Through; Disaggregated CPI; Structural Break; Oil Price Shock;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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