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Exchange Rate Uncertainty and Connectedness of Inflation

Author

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  • Sadettin Haluk Citci

    (Department of Economics, Gebze Technical University)

  • Hüseyin Kaya

    (Department of Economics, Istanbul Medeniyet University)

Abstract

In this study, we theoretically and empirically examine the connectedness of exchange rate uncertainty and inflation. In a small open economy setting with a flexible exchange rate and monopolistically competitive imported final goods sector, we show that price rigidities cause importers to carry exchange rate risk and they impose a premium for the risk they face by increasing consumer prices. This pricing behavior provides a channel between exchange rate uncertainty and overall price level. Then, we empirically analyze the impact of exchange rate uncertainty on inflation by using panel data from 149 countries over the period 19802017. The estimation results point that the uncertainty of the exchange rate has a significant and positive effect on inflation. Moreover, the degree of exchange rate pass-through and the effect of exchange rate uncertainty on inflation differ among country groups and their effects on inflation have decreased through time. We also show that the effect of exchange rate uncertainty on inflation is non-monotonic.

Suggested Citation

  • Sadettin Haluk Citci & Hüseyin Kaya, 2023. "Exchange Rate Uncertainty and Connectedness of Inflation," Working Papers 2022-01, Gebze Technical University, Department of Economics.
    • Handle: RePEc:geb:wpaper:2022-01
    as

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    References listed on IDEAS

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    More about this item

    Keywords

    exchange rate uncertainty; inflation; pricing power; exchange rate passthrough;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • 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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