Abstract
We use detailed data for Iceland to examine two often-neglected aspects of the exchange rate pass-through problem. First, we investigate whether the pass-through coefficient varies with the degree of international tradability of goods. Second, we analyze if the pass-through coefficient depends on the monetary policy framework. We consider 12 disaggregated price indexes in Iceland for 2003–2019, a period that includes Iceland’s banking and currency crisis of 2008. We find that the pass-through declined around the time Iceland reformed its flexible inflation targeting, and that the coefficients are significantly higher for tradable than for nontradables.
Highlights
The nominal exchange rate plays a dual role in the macroeconomic adjustment process
Πt is inflation, Ebt is the rate of change of the króna relative to a basket of currencies, the zt are other covariates, including international inflation, π∗
In this paper we have used a unique data set for Iceland to investigate some often neglected aspects of the exchange rate pass-through problem
Summary
The nominal exchange rate plays a dual role in the macroeconomic adjustment process. It is at the center of the transmission mechanism of monetary policy. Changes in the nominal exchange rate help accommodate shocks (both external and domestic) through changes in the real exchange rate (RER). These two roles are important in (very) open economies with inflation targeting regimes. For the exchange rate to play these two roles effectively, the pass-through needs to be different for different types of goods: it has to be (significantly) higher for tradables than for nontradables. If the pass-through is similar (or the same) for both
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