Exchange Rate Pass-Through in Brazil: А Markov Switching DSGE Estimation for the Inflation Targeting Period

Abstract

This paper investigates the nonlinearity of exchange rate pass-through in the Brazilian economy during the inflation targeting period (2000–2018) using a Markov-switching new Keynesian DSGE model. We find evidence of two distinct regimes for exchange rate pass-through and for the volatility of shocks to inflation. Under the so-called ‘normal’ regime, the long-run pass-through to consumer prices inflation is estimated as almost zero, only 0.00057 of a percentage point given a 1% exchange rate shock. In comprasion, the expected pass-through to inflation under a ‘crisis’ regime is 0.1035 of a percentage point, for the same exchange rate shock. These results allow us to identify four distinct cycles for exchange rate pass-through during the inflation targeting period in Brazil, and suggest that higher central bank credibility and anchored inflation expectations may be related to lower levels of pass-through.