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Is low inflation really causing the decline in exchange rate pass-through?

Listed author(s):
  • Miguel A. León-Ledesma

    ()

  • Reginaldo P. Nogueira Júnior

    ()

Recent literature has argued that exchange rate pass-through (ERPT) into domestic inflation has been declining in many countries following a dramatic change in inflation environment during the 1990s. Available empirical results face two central challenges: (i) the evidence on declining ERPT is mostlybased on sample-splitting approaches and hence subject to a degree of arbitrariness; and (ii) the link between a lower ERPT and inflation environment is usually based on simple correlation analysis and hence silent about temporal causality. We address these issues by making use of a state-space model that allows ERPT to be time-varying and dependent on the inflation environment. We estimate the model for 12 developed and emerging economies and test whether inflation contains significant information about the future evolution of the ERPT. The results reinforce the view of a smooth decline in the impact of exchange rates on domestic inflation, but do not support the hypothesis that lower inflation precedes this declining ERPT.

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File URL: ftp://ftp.ukc.ac.uk/pub/ejr/RePEc/ukc/ukcedp/1002.pdf
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Paper provided by School of Economics, University of Kent in its series Studies in Economics with number 1002.

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Date of creation: Apr 2010
Handle: RePEc:ukc:ukcedp:1002
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School of Economics, University of Kent, Canterbury, Kent, CT2 7NP

Phone: +44 (0)1227 827497
Web page: http://www.kent.ac.uk/economics/

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  2. Marlene Amstad & Andreas M. Fischer, 2005. "Time-varying pass-through from import prices to consumer prices: evidence from an event study with real-time data," Staff Reports 228, Federal Reserve Bank of New York.
  3. Jeannine Bailliu & Eiji Fujii, 2004. "Exchange Rate Pass-Through and the Inflation Environment in Industrialized Countries: An Empirical Investigation," Staff Working Papers 04-21, Bank of Canada.
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  17. Jeannine Bailliu & Hafedh Bouakez, 2004. "Exchange Rate Pass-Through in Industrialized Countries," Bank of Canada Review, Bank of Canada, vol. 2004(Spring), pages 19-28.
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