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Revisiting the Exchange Rate Pass Through: A General Equilibrium Perspective

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  • Mariana García-Schmidt
  • Javier Garcia-Cicco

Abstract

A large literature estimates the exchange rate pass-through to prices (ERPT) using reducedform approaches, whose results are an important input for analyses at Central Banks. We study the usefulness of these empirical measures for actual monetary policy analysis and decision making, emphasizing two main problems that arise naturally from a general equilibrium perspective. First, while the literature describes a single ERPT measure, in a general equilibrium model the evolution of the exchange rate and prices will differ depending on the shock hitting the economy. Accordingly, we distinguish between conditional and unconditional ERPT measures, showing that they can lead to very different interpretations. Second, in a general equilibrium model the ERPT crucially depends on the expected behavior of monetary policy, but the empirical approaches in the literature cannot account for this and thus provide a misleading guide for policy makers. We first use a simple model of a small and open economy to qualitatively show the intuition behind these two critiques. We then highlight the quantitative relevance of these distinctions by means of a DSGE model of a small and open economy with sectoral distinctions, real and nominal rigidities, and a variety of driving forces; estimated using Chilean data.

Suggested Citation

  • Mariana García-Schmidt & Javier Garcia-Cicco, 2018. "Revisiting the Exchange Rate Pass Through: A General Equilibrium Perspective," Working Papers Central Bank of Chile 826, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:826
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    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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