Exchange Rate Pass Through

11 Key excerpts on "Exchange Rate Pass Through"

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  Dynamic Optics in Economics: Quantitative, Experimental and Econometric Analyses

  • Hale Kirer Silva Lecuna(Author)
  • 2021(Publication Date)
  • Peter Lang Group

    (Publisher)

  Akın Usupbeyli Chapter 2 Asymmetric Exchange Rate Pass- through in Turkey: Evidence from Smooth Transition Models Abstract: This study examines the presence of asymmetric behavior in exchange rate pass- through (ERPT) to CPI inflation in Turkey for the period 2003:06– 2019:10 by using monthly data. Applying exponential nonlinear smooth transition models, the author tests to capture the asymmetry causing by the size of exchange rate changes. The findings show evidence that ERPT responds asymmetrically to the size of exchange rate changes as a result of presence of menu costs. The results indicate that when the exchange rate deviations are over 2 %, pass through to CPI inflation strengthens. Keywords: Exchange Rate Pass Through, CPI Inflation, Asymmetric Adjustment, Smooth Transition Regression 1. Introduction In a small open economy, especially where floating exchange rate regime is adopted, the reaction of the domestic prices to exchange rates constructs a major importance. Although Exchange Rate Pass Through is very easy to under- stand as a concept and can be considered as a natural process, its mechanism is complex and not easy to comprehend. This limited comprehension of the pass- through mechanism creates a frustration for the central banks of small open economies whose main task is to fight against inflation and to set monetary policies (Mishkin, 2008; Forbes et al., 2015). Technically, Exchange Rate Pass Through refers to the percentage change in domestic prices caused by a 1 % change in the exchange rate (Goldberg & Knetter, 1996). Rincón-Castro and Rodríguez (2016) present the factors that determine the magnitude of pass through as the degree of trade openness of the country, the degree of competition in which exporter and importers are faced in this market, the duration, the direction and the magnitude of the change in exchange rate and the share of imported input used in domestic production.

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  Exchange Rates and Macroeconomic Dynamics

  • P. Karadeloglou, V. Terraza, P. Karadeloglou, V. Terraza(Authors)
  • 2008(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Part II Exchange Rates Dynamics and Pass-Through Effects 4 Exchange Rate Pass-Through Effect and Monetary Policy in Russia Victoria V Dobrynskaya and Dmif:r)! V Levando 4.1 Introduction The term 'pass-through effect' (PTE) refers to the effect of changes in the exchange rate of a domestic currency for foreign currency (or a trade-weighted portfolio of foreign currencies) on the country's domestic prices for traded and non-traded goods. PTE of exchange rate changes on domestic prices is one of the major factors of trans- mission of shocks in an open economy. Lafleche (1996) offered a dia- gram, which described these mechanisms of reaction of domestic prices to depreciation of domestic currency. A variety of mechanisms through which a change in exchange rate affects all domestic prices are thoroughly described in Lafleche (1996). Before the end of the 1970s academic economists did not pay enough attention to this phenomenon. However, in recent years this topiC has became increas- ingly popular in many countries, perhaps in response to globalisation of the international markets and foreign trade growth. Higher PTE implies greater dependence of an open economy on external shocks in the world market and higher volatility of domestic prices due to changes in the exchange rate. Therefore, the government authorities should know the degree of PTE to forecast domestic inflation and con- duct adequate inflationary and exchange rate policies. The existing literature suggests that PTE in all of the studied coun- tries is significant (that is, depreciation of domestic currency leads to inflation), although incomplete (less than 100 per cent) in most cases. The literature also concludes that the degree of PTE depends greatly l1S 116 Exchange Rates and Macroeconomic Dynamics on the country and types of goods under consideration. One of the conclusions of the authors is that PTE is higher in smaller economies and in developing countries with high import shares.

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  Monetary Policy in the Context of Financial Crisis

  New Challenges and Lessons

  • Fredj Jawadi, William A. Barnett(Authors)
  • 2015(Publication Date)
  • Emerald Group Publishing Limited

    (Publisher)

  When assessing the stability of ERPT to consumer prices, we can specu-late that the introduction of the euro, as a major economic event, would entail a change in the behavior of the exchange rate transmission. The literature raised a number of reasons why the rate of pass-through may have changed for the EA members as a result of entering the monetary union. Namely, the introduction of the single European currency has chan-ged the competitive conditions by decreasing the share of trade exposed to exchange rate fluctuations. Also, the advent of the euro as well established currency in the 2000s, creating a single market for exporters, has favored an expansion of the euro as the currency of denomination of its external trade. Referring to these factors, one can think that ERPT has declined in monetary union members following that date. As a matter of fact, empiri-cal literature does not provide a strong evidence of structural break in pass-through coefficients since the creation of the euro area. In a set of stu-dies, Campa and Goldberg (2002, 2005) , Campa, Goldberg, and Gonza´ lez-Mı´nguez (2005) , and Campa and Gonza` lez (2006) have tested the presence of structural break in the vicinity of the introduction of the common currency. Their results do not support the view that ERPT has declined around the date of the creation of the euro. We have seen in the previous section that inflation environment (infla-tion level and inflation volatility) is an important macroeconomic factor influencing the ERPT. As argued by Taylor (2000) , the transition to the low inflation environment in many industrialized countries has successfully reduced the degree of pass-through to domestic prices. For the EA countries, the inflation convergence process has started before the adoption of the single currency, and more exactly, after the implementation of the Maastricht treaty.

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  Exchange Rates, Currency Crisis and Monetary Cooperation in Asia

  • R. Rajan(Author)
  • 2009(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Some empirical evidence of this has been reported by Gagnon Exchange Rate Pass-through in Korea and Thailand 81 and Ihrig (2004), Choudri and Hakura (2001) and Frankel et al. (2005) using macro level data for industrial countries. Another important macro variable that may affect the ERPT elasticities is exchange rate volatility. Devereux and Engel (2001) argue that if export- ers set their prices in the currency of the country that has stable mone- tary policy (i.e. local currency pricing as opposed to producer currency pricing) then ERPT into import prices in local currency terms will be low for countries with low monetary and exchange rate variability . 8 In con- trast, Froot and Klemperer (1989) contend that ERPT is low when nominal exchange rate volatility is high as exporters try to preserve market share. They view exchange rate volatility as temporary fluctuations in exchange rates in any one direction, leading exporters to absorb these shocks in their mark-ups and profit margins. We also examine whether the extent of trade openness impacts ERPT. On the one hand, greater openness ought to imply that domestic prices are more directly and significantly impacted by exchange rate changes. Thus, one would expect ERPT to be higher. On the other hand, greater openness may also imply higher degree of compe- tition for market share, thus implying lower ERPT . We test for the role of these macroeconomic variables by regressing the time varying ERPT elasticities obtained from the recursive estima- tions on lagged inflation rate, lagged exchange rate volatility and trade openness. 9 Moreover, we use a dummy that has a value of 1 for 1997:q2– 1998:q2 and 0 otherwise to capture any impact of the specific period of the currency crisis. ' ˆ i t x ' ˆ i 1 (5) where d = [d 0 , d 1 , d 2 , d 3 , ], x t = t [lagged inf lation rate, lagged exchange rate volatility , y trade openness, crisis dummy]. For inf lation rate we use per- centage change of CPI for both Korea and Thailand.

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  The Gains and Pains of Financial Integration and Trade Liberalization

  Lessons from Emerging Economies

  • Rajib Bhattacharyya(Author)
  • 2019(Publication Date)
  • Emerald Publishing Limited

    (Publisher)

  Finally, a rise in exchange rate feeds into the domestic price level (though imperfectly) and reduces real value of money holding or wealth, reducing consumption (through real balance effect) and hence, aggregate demand. From Fig. 14.1, it is clearly evidenced that there is a co-movement in exchange rate and inflation rate. It alludes to the phenomenon of a long-run stable relation between the two variables, and this is the area of focus of this chapter. Against this backdrop, it has become extremely important to empirically measure the degree of pass-through of exchange rate to domestic prices. The rest of the chapter is arranged as follows. Section 2 provides a brief literature survey. Section 3 elaborates the methodology used to examine the problem at hand and thereafter, derives the results. Finally, we conclude the chapter in Section 4. Literature Survey Different economists have used different frameworks to measure the degree of pass-through. The Bank of Israel uses an open economy version of a New Keynesian Phillips curve relating inflation and exchange rate (Elkayam, 2004). Longworth (2002) too uses a Phillips curve relation to examine the impact of exchange rate movements on consumer prices. While the aforementioned studies estimate pass-through equations with aggregated data, some authors also introspect the degree of pass-through in various sectors like Goldberg and Knetter (1997), Campa and Goldberg (2002), and Bugamelli and Tedeschi (2004). Several papers also estimate pass-through for a panel of countries, like Bailliu and Fuji (2004) and Mohanty and Klau (2001). However, these studies neglect India. Only a few economists concentrate on the Indian economy. Ghosh and Rajan (2007) use a sample that ranges from Q1 1980 to Q2 2005, and using a co-integration approach, find evidence of long-run elasticity of 40% and short-run elasticity of 10%. They also opine that ERPT has risen post liberalization

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  Exchange Rate Analysis in Support of IMF Surveillance : A Collection of Empirical Studies

  • Charalambos Tsangarides, Carlo Cottarelli, Gian Milesi-Ferretti, and Atish Ghosh(Authors)
  • 2008(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  In the presence of local distribution costs, firms may also face offsetting factors when the exchange rate changes, leading to international price discrimination and incomplete pass–through (see Corsetti and Dedola, 2002, and Choudhri, Faruqee, and Hakura, 2002). These factors can help account for the difference in responses between “first–stage” pass–through (for example, in import prices) and “second–stage” pass–through (for example, in consumer prices). Moreover, these considerations have been shown to have important implications for optimal monetary and exchange rate policies (see, for example, Corsetti and Pesenti, 2002, and Devereux and Engel, 2003). This chapter examines exchange rate pass–through and its behavioral determinants in the euro area. The methodology proceeds in two parts. First, the empirical analysis follows a vector autoregression (VAR) approach, in which the time–series behavior of the euro exchange rate and a system of euro area prices are examined. Specifically, the empirical analysis investigates exchange rate pass–through into a set of prices along the pricing chain. Second, the impulse response functions (IRFs) from the VAR estimation are used to calibrate in a new open economy macroeconomics model the key behavioral parameters that can help reproduce the pattern of pass–through and external adjustment in the euro area. The use of a VAR approach to examine exchange rate pass–through has several advantages compared with single–equation methods. Previous studies typically have focused on pass–through into a single price (for example, import or consumer prices) without further distinguishing between the types of underlying exchange rate shocks (for example, permanent or transitory) that may be occurring. By investigating exchange rate pass–through into a set of prices along the pricing chain, the VAR analysis characterizes not only absolute but relative pass–through in upstream and downstream prices

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  The Brazilian Economy since the Great Financial Crisis of 2007/2008

  • Philip Arestis, Carolina Troncoso Baltar, Daniela Magalhães Prates, Philip Arestis, Carolina Troncoso Baltar, Daniela Magalhães Prates(Authors)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  From a macroeconomic perspective, the exchange rate pass-through may be asymmetric if the Monetary Authority is concerned with infla- tionary pressures arising from exchange rate movements and reacts more strongly after a currency devaluation than after an appreciation (Delatte and Villavicencio 2012). Furthermore, the exchange rate pass-through may depend on the level of economic activity. In periods of economic recessions, for example, the effects of a depreciation in raising prices may be smaller than the effects of an appreciation in reducing domestic prices (Goldfajn and Werlang 2000). In general, literature suggests that price adjustments to exchange rate fluctuations depend on market structures and firm pricing strate- gies, which will differ from industry to industry and from country to country. 14 The existence and direction of asymmetric exchange rate pass-through to prices may not be asserted a priori. Generally, industries 14 According to Goldfajn and Werlang (2000) and Calvo and Reinhart (2000) ERTP is higher for the emerging countries than for developed countries. Additionally, in emerging countries, with currencies placed at the lower end of the currency hierarchy, exchange rate is prone to be more volatile (Paula et al. 2017). Asymmetric Exchange Rate Pass-Through … 81 producing homogeneous and globally marketable products should pre- sent a higher pass-through and less possibility of asymmetry, whereas industries whose products are more differentiated and where market structure is less competitive have greater possibility of presenting asym- metries and nonlinearities. 4 Asymmetric Exchange Rate Pass-Through: Empirical Evidence from Brazil (1999–2016) Data Base The econometric model estimated is based on Belaisch (2003) and Araújo and Modenesi (2010), and own elaboration as above, and is extensively used in the Brazilian exchange rate pass-through literature.

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  Exchange Rate, Second Round Effects and Inflation Processes

  Evidence From South Africa

  • Eliphas Ndou, Nombulelo Gumata, Mthokozisi Mncedisi Tshuma(Authors)
  • 2019(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  absence of the ERPT channel .

  9.1 Introduction

  The long period during which the consumer price inflation exceeded 6% between 2016M1 and 2017M3, was accompanied by the declining exchange rate pass-through (ERPT ) to consumer price inflation as shown in Fig. 9.1 a, and an appreciation in the nominal effective exchange rate (NEER) in part (b). In addition, the peak of policy rate tightening cycle in 2016 coincided with a decline in ERPT in Fig. 9.1 c, and an appreciation in the NEER in part (d). These developments point to the need to determine the applicability of the Taylor (2000 ) hypothesis and the relevance of the Gagnon and Ihrig (2004 ) findings in South Africa.

  Fig. 9.1

  Trends of ERPT , inflation, exchange rate and the repo rate. Note The NEER is inverted such that an increase (decrease) implies a depreciation (appreciation). The growth refers to annual growth

  (Source South African Reserve Bank and authors’ calculations)

  The research studies for instance, Aleem and Lahiani (2014 ) attribute the decline in ERPT to a change in the inflationary environment and the credibility of monetary policy conduct. The Taylor hypothesis suggests that a credible monetary policy which controls inflation will lower the ERPT by reducing the perceived persistence of the shocks affecting the firm’s costs. In addition, the Gagnon and Ihrig (2004 ) findings suggest that the aggression of the monetary policy reaction towards inflation will lead to a slowdown in the ERPT to inflation . Furthermore, Devereux and Yetman (2002 ) postulate that the frequency of price changes depends on monetary policy reaction. A credible monetary policy reduces the frequency of price changes.

  Hence, it is important for this chapter to investigate whether the monetary policy channel impacts

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  Inflation Dynamics in South Africa

  The Role of Thresholds, Exchange Rate Pass-through and Inflation Expectations on Policy Trade-offs

  • Eliphas Ndou, Nombulelo Gumata(Authors)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Indeed, the presence of demand pressures tends to propagate the impact of inflationary shocks on headline inflation. 16.6 Conclusion and Policy Implications We have shown evidence of non-linearity in ERPT to import price inflation beyond a threshold exchange rate depreciation of 0.28 per cent. In addition, there is high persistence of import price inflation in higher exchange rate depreciation regime than in the low exchange rate changes regime. Import price display asymmetries to large compared to small depreciations or appreciations above the exchange rate threshold. At the same time, GDP growth amplifies the responses of headline inflation Fig. 16.7 Amplifications due to GDP growth and exchange rate changes. Source: Authors’ calculations 16 Where Does the Exchange Rate Pass-Through to Import Price. . . 243 to import price inflation by 9.4 per cent which is larger than the 1.6 per cent due to exchange rates. In policy terms, this means that inflation will tend to exhibit more stickiness (persistence) at higher levels in the pres- ence of rand depreciation regimes. References Balke, N. S. (2000). Credit and economic activity: Credit regimes and the nonlinear propagation of shocks. Review of Economics and Statistics, 82(2), 516–536. Campa, J. M., & Goldberg, L. S. (2006). Pass through of exchange rates to consumption prices: What has changed and why? NBER Working Papers 12547, National Bureau of Economic Research, Inc. Devereux, M. B., & Engel, C. 2001. Endogenous currency of price setting in a dynamic open economy model. NBER Working Papers 8559, National Bureau of Economic Research, Inc. Goldberg, L. S. 2004. Industry-specific exchange rates for the United States. Economic Policy Review, Federal Reserve Bank of New York, May, 1–16. Pentecôte, J. S., & Rondeau, F. (2015). Trade spillovers on output growth during the 2008 financial crisis. International Economics, 143, 36–47. Pollard, P. S., & Coughlin, C.

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  International Financial Issues in the Pacific Rim

  Global Imbalances, Financial Liberalization, and Exchange Rate Policy

  • Takatoshi Ito, Andrew K. Rose, Takatoshi Ito, Andrew K. Rose(Authors)
  • 2008(Publication Date)
  • University of Chicago Press

    (Publisher)

  Fifth, Taylor (2000) argues the low inflation in the United States during early 2000 has also meant lower persistence of inflation. Conceptually, changes in expectation will reduce the persistence of cost and prices changes. As a result, the volatility in exchange rate is not transmitted into prices. This argument leads into a question of whether the decline in the ex-change rate pass-through in the U.S. was due to an inflation (the role of monetary policy) or distribution services? How do we decompose those two e ff ects? Sixth, what is the role of market shares in the pass-through e ff ect? To maintain the market shares, when there are substitutes available, firms will do some pricing-to-market which will reduce pass-through. I think some comparisons between some competitive and less competitive sectors may be useful to answer this question. In sum, this chapter is worth reading and o ff ers an important contribu-tion for the study of the role of distribution margins and imported inputs in exchange rate transmission into the consumption prices. This excellent paper also draws some important implications for expenditure switching and trade adjustment from changes in exchange rates over time. In addi-tion, various lessons can be drawn from this paper, particularly in relation to the role of distribution margins and imported input in exchange rate pass-through. References Campa, Jose and L. Goldberg. 2006. Distribution margins, imported inputs and the sensitivity of the CPI to exchange rates. NBER Working Paper no. 12121. Cambridge, MA: National Bureau of Economic Research. Hyder, Z., and S. Sardar. 2005. 2005. Exchange rates pass-through to domestic prices in Pakistan. Macroeconomics, no. 0510021, October. Marazzi, M., N. Sheets, R. Vigfusson, J. Faust, J. Gagnon, J. Marquez, R. Martin, Pass-Through of Exchange Rates to Consumption Prices 173 T. Reeve, and J. Rogers. 2005. Exchange rate pass-through to U.S.

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  Understanding Interdependence

  The Macroeconomics of the Open Economy

  • Peter B. Kenen(Author)
  • 2021(Publication Date)
  • Princeton University Press

    (Publisher)

  Sixth, our work draws attention to two especially notable, even paradoxical, developments: the net decline in the relative price of Japanese exports over the past ten years in the face of a sharp appreciation of the yen, and the comparative stability of the relative price of U.S. imports (excluding oil and computers) over roughly the same period in the face of a significant depreciation of the dollar. These two developments are no doubt interrelated to some degree, and the second, in particular, is consistent with, but does not necessarily confirm, the presence of hysteresis.

  Seventh, the substantial literature on exchange-rate pass-through that has sprouted during the past decade has contributed some interesting new theoretical insights but has probably not greatly affected the validity of conventional empirical estimates of the effects of exchange rates on import and export prices.

  Finally, Japanese exporters tend to pass through a significantly smaller percentage of any given exchange-rate change than do U.S. exporters. Much of this difference may be attributable, however, to the greater sensitivity of Japanese production costs to exchange-rate changes; Japanese export prices fall when the yen appreciates, partly because the prices of petroleum and other raw materials fall in Japan.

  Appendix A: Real Exchange Rates, Relative Prices, and the Terms of Trade

  As noted in the text, a variety of alternative measures of relative prices and real exchange rates have been used to model trade flows and external balances. These measures are far from uniform, however, and can show widely varying movements over time. The purpose of this appendix is to provide a brief analysis of the conceptual relationships among relative prices, real exchange rates, and the terms of trade and to document how widely these series have differed empirically over the past two decades for both the United States and Japan. Marston (1987) presents a more comprehensive analysis of the theoretical relationships among alternative measures of real exchange rates. Marquez (1992) provides a detailed empirical analysis of several different measures of real exchange rates and their performance in U.S. trade equations.

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