Exchange Rate Pass-Through Effect and Monetary Policy in Russia

Abstract

The term ‘pass-through effect’ (PTE) refers to the effect of changes in the exchange rate of a domestic currency for foreign currency (or a trade-weighted portfolio of foreign currencies) on the country’s domestic prices for traded and non-traded goods. PTE of exchange rate changes on domestic prices is one of the major factors of transission of shocks in an open economy. Lafleche (1996) offered a diagram, which described these mechanisms of reaction of domestic prices to depreciation of domestic currency. A variety of mechanisms through which a change in exchange rate affects all domestic prices are thoroughly described in Lafleche (1996). Before the end of the 1970s academic economists did not pay enough attention to this phenomenon. However, in recent years this topic has became increasingly popular in many countries, perhaps in response to globalisation of the international markets and foreign trade growth. Higher PTE implies greater dependence of an open economy on external shocks in the world market and higher volatility of domestic prices due to changes in the exchange rate. Therefore, the government authorities should know the degree of PTE to forecast domestic inflation and conduct adequate inflationary and exchange rate policies.