Abstract
In this paper, we estimate the pass-through impact of exchange rate movements on domestic prices between January 1994 and December 2012, using a recursive VAR. The model consists of six variables, which are ordered as: oil prices, output gap, exchange rate, non-food prices, overall consumer prices, and money market interest rates with the implicit assumption that the identified shocks contemporaneously impact variables ordered after the shock without a contemporaneous feedback. We establish that the effect of a nominal exchange rate shock on domestic prices is incomplete, broadly modest and decays within 18-24 months, but such effects are mostly felt within 12 months. Generally, the impact of the exchange rate shock on overall CPI inflation is more benign than for non-food inflation. We also find evidence in support of Taylor’s hypothesis that the exchange rate pass-through is positively correlated with the level of inflation.
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