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Forecasting Industry-Level CPI and PPI Inflation: Does Exchange Rate Pass-Through Matter?

We examine whether industry-level forecasts of CPI and PPI inflation can be improved when we use the “exchange rate pass-through” effect, that is, when we account for the variability of the exchange rate and import prices. We build a forecasting model based on a two or three equation system involving CPI and PPI inflation where the effects of the exchange rate and import prices are explicitly taken into account. This setup also incorporates their dynamics, lagged correlations and appropriate restrictions suggested by economic theory. We compare the forecasting performance of our model with a variety of unrestricted univariate, multivariate time series models with and without standard control variables for inflation, like interest rates and unemployment. Our results suggest that improvements on the forecast accuracy can be effected when one takes into account the possible pass-through effects of exchange rates and import prices on CPI and PPI inflation.

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File URL: http://www.deakin.edu.au/buslaw/aef/workingpapers/papers/2006-10eco.pdf
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Paper provided by Deakin University, Faculty of Business and Law, School of Accounting, Economics and Finance in its series Economics Series with number 2006_10.

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Length: 49 pages
Date of creation: 23 Oct 2006
Date of revision:
Handle: RePEc:dkn:econwp:eco_2006_10
Contact details of provider: Postal: 221 Burwood Highway, Burwood 3125
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Web page: http://www.deakin.edu.au/buslaw/aef/index.php

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  1. Maurice Obstfeld and Kenneth Rogoff., 1999. "New Directions for Stochastic Open Economy Models," Center for International and Development Economics Research (CIDER) Working Papers C99-107, University of California at Berkeley.
  2. Jonathan McCarthy, 2000. "Pass-through of exchange rates and import prices to domestic inflation in some industrialized economies," Staff Reports 111, Federal Reserve Bank of New York.
  3. Pinelopi Koujianou Goldberg & Michael M. Knetter, 1997. "Goods Prices and Exchange Rates: What Have We Learned?," Journal of Economic Literature, American Economic Association, vol. 35(3), pages 1243-1272, September.
  4. Maurice Obstfeld., 2001. "International Macroeconomics: Beyond the Mundell-Fleming Model," Center for International and Development Economics Research (CIDER) Working Papers C01-121, University of California at Berkeley.
  5. Prasad Bhattacharya & Cem A. Karayalcin & Dimitrios D. Thomakos, 2006. "Exchange Rate Pass-Through and Relative Prices: An Industry-Level Empirical Investigation," Economics Series 2006_17, Deakin University, Faculty of Business and Law, School of Accounting, Economics and Finance.
  6. Diebold, Francis X & Mariano, Roberto S, 1995. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(3), pages 253-63, July.
  7. Maurice Obstfeld, 2002. "Exchange Rates and Adjustment: Perspectives from the New Open Economy Macroeconomics," NBER Working Papers 9118, National Bureau of Economic Research, Inc.
  8. Adolfson, Malin, 2001. "Export price responses to exogenous exchange rate movements," Economics Letters, Elsevier, vol. 71(1), pages 91-96, April.
  9. Spanos, Aris, 1989. "Early Empirical Findings on the Consumption Function, Stylized Facts or Fiction: A Retrospective View," Oxford Economic Papers, Oxford University Press, vol. 41(1), pages 150-69, January.
  10. Clements, Michael P & Smith, Jeremy, 1999. "A Monte Carlo Study of the Forecasting Performance of Empirical SETAR Models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 14(2), pages 123-41, March-Apr.
  11. José Manuel Campa & Linda S. Goldberg, 2005. "Exchange Rate Pass-Through into Import Prices," The Review of Economics and Statistics, MIT Press, vol. 87(4), pages 679-690, November.
  12. Linda S. Goldberg, 2004. "Industry-specific exchange rates for the United States," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 1-16.
  13. Pecchenino, R. A., 1992. "Commodity prices and the CPI: Cointegration, information, and signal extraction," International Journal of Forecasting, Elsevier, vol. 7(4), pages 493-500, March.
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  17. Laurence Ball, 1997. "Efficient rules for monetary policy," Reserve Bank of New Zealand Discussion Paper Series G97/3, Reserve Bank of New Zealand.
  18. Heravi, Saeed & Osborn, Denise R. & Birchenhall, C. R., 2004. "Linear versus neural network forecasts for European industrial production series," International Journal of Forecasting, Elsevier, vol. 20(3), pages 435-446.
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  20. Sven W. Arndt & J. David Richardson, 1987. "Real-Financial Linkages Among Open Economies," NBER Working Papers 2230, National Bureau of Economic Research, Inc.
  21. Ki-Ho Kim, 1998. "US inflation and the dollar exchange rate: a vector error correction model," Applied Economics, Taylor & Francis Journals, vol. 30(5), pages 613-619.
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  24. Coakley, Jerry & Fuertes, Ana-Maria, 2001. "Border costs and real exchange rate dynamics in Europe," Journal of Policy Modeling, Elsevier, vol. 23(6), pages 669-676, August.
  25. Swanson, Norman R. & White, Halbert, 1997. "Forecasting economic time series using flexible versus fixed specification and linear versus nonlinear econometric models," International Journal of Forecasting, Elsevier, vol. 13(4), pages 439-461, December.
  26. Taylor, John B., 2000. "Low inflation, pass-through, and the pricing power of firms," European Economic Review, Elsevier, vol. 44(7), pages 1389-1408, June.
  27. Bergin, Paul R., 2003. "Putting the 'New Open Economy Macroeconomics' to a test," Journal of International Economics, Elsevier, vol. 60(1), pages 3-34, May.
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