Abstract
PurposeThe theoretical and empirical literature stipulated that exchange rate shocks do influence the domestic price of imports. Hence, this paper aims to investigate the underlying relationship between the exchange rate and prices known as the exchange rate pass-through.Design/methodology/approachThe paper uses a structural vector auto-regression (SVAR) model, drawing on Bernanke (1986) and Sims (1986), to empirically examine and analyze the pass-through of exchange rate fluctuations to domestic prices in Egypt.FindingsThe empirical results of the monthly data between 2003 and 2015 revealed that the exchange rate pass-through in Egypt is fairly substantial but incomplete and slow in the three price indices [IMP, producer price index and consumer price index (CPI)]. However, the impact is more prominent for consumer prices than for any other price index. This finding could be attributed to the fact that the CPI in Egypt is composed of a relatively large number of subsidized commodities and goods with administered prices as well as the authorities’ behavior in manipulating prices (i.e. export ban). This is expected to weaken the transmission of exchange rate shocks.Practical implicationsThe result has interesting implications for Egypt’s ability to attain an effective inflation targeting regime.Originality/valueThe study contributes to the literature by assessing the effect of changes in the exchange rate (the Egyptian £vis-à-visthe US$) on prices using an updated time series from 2003 to 2015. It addresses the limitations of the study of Nafieet al.(2004), which found no strong relationship between the exchange rate and inflation rate in the Egyptian context. One of these limitations was using the CPI, as the only price index.
Highlights
Egypt’s macroeconomic policies have significantly evolved since the 1990s
For the consumer price index (CPI), its positive response to shocks in exchange rate is quite larger than its response to shocks in import prices (IMPs), implying that the indirect transmission channel of pass-through is stronger than the direct channel in Egypt
IMPs explain little of the variance of producer prices, only 3.37 per cent by the 24th month. These results support the findings of the impulse response functions (IRFs) that suggest that the indirect exchange rate pass-through channel, is stronger than direct channel (i.e. IMP changes to producer prices) in Egypt
Summary
Egypt’s macroeconomic policies have significantly evolved since the 1990s. Its exchange rate regime varied over the past decades. Economic agents consider that a change in the exchange rate is permanent and will have a permanent impact on their production costs. In flexible regimes, economic agents consider changes in the exchange rate as temporary They do not adjust their selling prices immediately. Taylor’s model demonstrated that experiencing a lower inflation environment (e.g. because of an inflation-targeting policy) may lead to a lower degree of persistence of price shocks, decreasing the degree of the exchange rate pass-through
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