Abstract
AbstractThis paper studies the effect of exchange rate pass-through on inflation in Tunisia for the period 2001 to 2009. The objective is to track inflation regimes for the Tunisian economy and to forecast its determinants. Using a Markov-switching approach, the authors identified two main regimes for inflation in Tunisia during this period: a low and stable inflation regime associated with a low pass-through level and a high inflation regime associated with a high pass-through level. To highlight the mechanisms underlying shifts in inflation regimes, the authors used a time-varying probabilities approach and identified a set of variables to assess their effects on inflation in Tunisia. The results show that the price level decreases in response to an increase in interest rates. Along with this, the empirical results provide strong evidence that the industrial production index has a negative and significant effect, as it increases the probability to stay in an inflationary regime and remain at a high pass-through level. The results also show robust support for the hypothesis that the imports increase the probability to stay in a high-inflation regime and maintain a high pass-through level. However, exports increase the probability of staying in a low-inflation regime and maintaining a low pass-through level.
Highlights
Inflation and its determinants have been among the important issues of concern to economists
This paper examined theoretically and empirically the impact of exchange rate changes on inflation and described the nature, degree and direction of the relationship between the nominal exchange rate and inflation for the Tunisian economy, mainly, the dynamic governing the transmission mechanism of exchange rate changes on consumer prices
Using Fixed Transition Probability and Time varying transmission probability-Markov-switching approaches, we investigated the existence of a relationship between pass-through and inflation
Summary
Inflation and its determinants have been among the important issues of concern to economists. The liberalization and modernization of financial markets as well as changes in stabilization policies have caused changes in the inflation process. After a long period of relative price stability both in developed and developing countries, inflation has re-emerged around the world as a global challenge with serious socio-economic implications. Tunisia is concerned with this challenge as the process of economic and financial liberalization, since the establishment of the convertibility of its current account in January 1993, is pursued. Tunisia has already begun the process of opening its domestic market to international capital flows. She has adopted more market-based monetary policy tools and is currently planning to progressively opt for greater exchange rate flexibility (Ben Ali, 2007). To be able to react on time, the BCT will need to base its monetary policy decisions not on past inflation outcomes but on inflation forecasts (Senhadji, Saadi and Kpodar, 2007)
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