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Exchange Rate Pass-Through and Irish Import Prices

Author

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  • Kenny, Geoff

    (Central Bank and Financial Services Authority of Ireland)

  • McGettigan, Donal

    (Central Bank and Financial Services Authority of Ireland)

Abstract

This study assesses the extent to which exchange rate changes affect Irish import prices (i.e. the extent of exchange rate pass-through, PT) by analysing data from the 1963 to 1995 period. The paper fills two important gaps in the literature: i) by making due allowance for the time series properties of the data and ii) by concentrating on the case of a small open economy. The majority of international empirical studies in the area do not provide support for full, or close to full, PT. Reasons put forward for this finding include the "menu" costs associated with altering prices, hedging techniques, intra-firm pricing by multinationals, the existence of non-tariff barriers, and the entry/exit of firms associated with exchange rate induced price changes. If the proposition of monetary neutrality is accepted, however, full PT would be expected to hold over the medium to long run. Many previous studies assess the degree of PT by relating import prices to the exchange rate, foreign costs and domestic competing prices. The usual approach involves estimating a single equation and using the estimated coefficients to assess the degree of PT. It is argued in this paper, however, that such single equation estimation will lead to estimates of the degree of PT which appear too low because the strong relationship between import and domestic-competing prices will not be properly taken into account using such a technique. This study makes use of the so-called Johansen technique to allow for this problem and uncovers two long-run relationships among the data, i.e. one between import unit values, the exchange rate and foreign costs and another between domestic competing prices and the same two variables. In so doing, it confirms the existence of very close to full PT in the case of both Irish import prices and domestic competing prices. Many of the previous results in the literature demonstrating substantially less than full PT may be due to the failure to make proper allowance for the time series properties of the data or for the strong relationship which exists between import and domestic competing prices. Finally, it is found that the speed of adjustment to the long-run relationships appears to be quite low, thus supporting the existence of incomplete PT in the short run.

Suggested Citation

  • Kenny, Geoff & McGettigan, Donal, 1996. "Exchange Rate Pass-Through and Irish Import Prices," Research Technical Papers 6/RT/96, Central Bank of Ireland.
  • Handle: RePEc:cbi:wpaper:6/rt/96
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    References listed on IDEAS

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    1. Menon, Jayant, 1994. "The Theory of Exchange Rates and Traded Goods Prices in the Short-Run," Economia Internazionale / International Economics, Camera di Commercio Industria Artigianato Agricoltura di Genova, vol. 47(1), pages 55-68.
    2. Baldwin, Richard, 1988. "Hyteresis in Import Prices: The Beachhead Effect," American Economic Review, American Economic Association, vol. 78(4), pages 773-785, September.
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    4. Browne, Francis X, 1982. "Modelling Export Prices and Quantities in a Small Open Economy [The Supply and Demand for Exports: A Simultaneous Approach]," The Review of Economics and Statistics, MIT Press, vol. 64(2), pages 346-347, May.
    5. Kenny, Geoff & McGettigan, Donal, 1996. "Non-Traded, Traded and Aggregate Inflation In Ireland (Part 2)," Research Technical Papers 3B/RT/96, Central Bank of Ireland.
    6. Menon, Jayant, 1996. "The Degree and Determinants of Exchange Rate Pass-through: Market Structure, Non-tariff Barriers and Multinational Corporations," Economic Journal, Royal Economic Society, vol. 106(435), pages 434-444, March.
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    11. Gonzalo, Jesus, 1994. "Five alternative methods of estimating long-run equilibrium relationships," Journal of Econometrics, Elsevier, vol. 60(1-2), pages 203-233.
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    13. Johansen, Søren & Juselius, Katarina, 1992. "Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK," Journal of Econometrics, Elsevier, vol. 53(1-3), pages 211-244.
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    Cited by:

    1. Tokhir Mirzoev, 2004. "A Dynamic Model of Endogenous Exchange Rate Pass-Through," International Finance 0409002, EconWPA.
    2. Martins Bitans, 2004. "Pass-Through of Exchange Rates to Domestic Prices in East European Countries and the Role of Economic Enviroment," Working Papers 2004/04, Latvijas Banka.
    3. Colin Bermingham, 2006. "Employment and Inflation Responses to an Exchange Rate Shock in a Calibrated Model," The Economic and Social Review, Economic and Social Studies, vol. 37(1), pages 27-46.
    4. M. Abimbola Oyinlola & M. Adetunji Babatunde, 2009. "A Bound Testing Analysis Of Exchange Rate Pass- Through To Aggregate Import Prices In Nigeria: 1980-2006," Journal of Economic Development, Chung-Ang Unviersity, Department of Economics, vol. 34(2), pages 97-109, December.
    5. Bermingham, Colin, 2008. "Quantifying the Impact of Oil Prices on Inflation," Research Technical Papers 8/RT/08, Central Bank of Ireland.

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