Comment on “A Pass-Through Revival”

Abstract

Exchange rate adjustments … weren't always reflected in the final prices of exports and imports. Following the last upward valuation of the Japanese yen, many Japanese exporters simply absorbed the increase, reducing their profit margins instead of raising prices. And many American international companies took the last dollar devaluation as an opportunity to increase the profit margins of their overseas affiliates instead of cutting prices. In the exchange rate pass-through literature, the seminal theoretical paper by Dornbusch (1987) emphasizes the price setting role of exporters in imperfectly competition markets to explain the less than proportionate response of export prices to exchange rate fluctuations. After Dornbusch (1987), a large number of theoretical and empirical studies have focused on the price-setting behaviors of exporters. Surely the important policy implications of exchange rate pass-through are originally on import side, but as discussed above, the developments in this research area have been inclined more toward exporters' pricing behaviors. Now given the current situation in Japan that after the decades-long period of small-inflation (or deflation), the change in monetary policy of Japan calls for inflation of 2% within two years, our attention should be focused more on the price transmission from import prices to final consumer prices. In this sense, I totally agree with Shioji's (2014) emphasis that discussions of the “pass-through on import side” need to be revived. Now, it remains to evaluate quantitatively how important this channel is for inflation in Japan. Shioji's paper investigates the price transmission mechanism by examining prices at different stages: the import price; prices at intermediate stages; and the consumer price. Price series are included in a standard vector autoregressive model (VAR) and a more sophisticated VAR with time-varying coefficients and stochastic volatilities. The impulse responses of the standard VAR model in Shioji's (2014) Figure 2 and Table 2 indicate an upward shift in recent years. In addition, taking advantage of the time-varying coefficients VAR, the impulse response in different periods are tested to see whether the degree of pass-through transmission has changed over time. Shioji finds evidence for an increase in the degree of pass-through in the latest period (see Shioji's, (2014) Figure 3 and Table 3), and concludes that exchange rate pass-through to import prices has risen. Shioji further relates the cause of pass-through changes to the change in the proportion of imported inputs (in terms of value) using input-output analysis. How relevant is this pass-through issue to current Japan's monetary policy? Shioji answers this question by giving a rough forecast of the impact of the 25% depreciation of the Japanese yen on inflation to be 1% in 6 months. Thus, I agree that “pass-through revival” is normatively important in Japan's current economic situation, that is, an economy that has suffered deflation for a long period and has a zero-lower-bound interest rate, as well as being quantitatively important for the inflation target of two percent in 2 years. Having said that and with all due respect to Shioji's paper, I shall raise one issue that I am not completely in agreement with Shioji. In the introduction of his paper, Shioji (2014, p. 121) argues that “this apparent revival of pass-through likely means that the central bank has regained an important transmission mechanism of its policy to the private sector.” If the Bank of Japan (BoJ) is able to maneuver a depreciation of the Japanese yen, the BoJ may successfully lead the consumer price index (CPI) to its targeted goal of 2% inflation. However, the BoJ cannot rely on direct intervention in the foreign exchange market. The failure or short-lived effects of central bank intervention in foreign exchange markets are well documented, especially in the 2003 and 2004 episodes, and the more recent BoJ interventions after 2010. How and why the Japanese yen depreciated by 25% (without interventions in the foreign exchange markets) between October 2012 and May 2013 needs to be examined more carefully, and further study is warranted. Clarifying quantitatively the underlying mechanism which did not work in the last two decades and that worked in 2012–2013 would strengthen the credibility of the policy tools available to the BoJ as Shioji claims.