Abstract
PurposeThis paper aims to investigate the pass-through (PT) effect in Turkey by using quarterly data for the period 1998: Q1-2019: Q2 to understand the dynamic potential effects of exchange rates on domestic prices.Design/methodology/approachThe paper launches several nonlinear models in which the basic determinants of domestic prices in Turkey are determined through Markov regime-switching models (MSMs). Hence, this research follows the variables of the consumer price index (CPI), USD exchange rate, gross domestic product (GDP; demand side of the economy), industrial production index (production side of the economy), economic uncertainty and geopolitical risk index for Turkey.FindingsThis work explores that the exchange rate and demand side of the economy (GDP) follow a positive nonlinear relationship with CPI at both regimes. The production side of the economy (IP) affects negatively the CPI during regime 0. Economic uncertainty influences the CPI positively at Regime 1, while geopolitical risk has a negative association with CPI at Regime 0. Eventually, the paper provides some policy proposals associated with the impacts of GDP, IP, economic uncertainty and geopolitical risk on CPI in Turkey.Originality/valueOne may claim that any PT model, which does not observe the possible structural or regime shifts in estimated parameters, might fail to estimate the coefficients unbiasedly and efficiently. Hence, this work differs from available relevant works in the literature since this paper considers linearity or nonlinearity important and reveals that the relevant PT model follows a nonlinear path rather than a linear path, this nonlinear path is converged strongly by MSMs and estimates the significant regime shifts in the constant term and, in parameters of independent variables of PT by MSMs.
Highlights
The pass-through (PT) effect is defined as the impact of the changes in exchange rates on domestic prices (Menon, 1996; McCarthy, 2000)
Markov regime-switching model The Markov regime-switching (MS) model, one of the nonlinear models pioneered by Hamilton (1989), is widely used in economics and finance literature (Engel and Hamilton, 1990; Bilgili et al, 2012; Dogan and Bilgili, 2014; Ning and Zhang, 2018; Jin et al, 2020)
Data and estimation output This paper considers the nexus between PT effect and economic uncertainty, with the variables of consumer price index (CPI), USD exchange rate, Gross domestic product, Industrial production index, Economic uncertainty index and Geopolitical risk index for Turkey
Summary
The pass-through (PT) effect is defined as the impact of the changes in exchange rates on domestic prices (Menon, 1996; McCarthy, 2000). It can measure the effect of exchange rates on the import and export prices (Sekine, 2006). With the rise of exchange rates, the increases in the demand for import substitution goods and the export goods will raise the prices of these goods (McFarlane, 2002). This later outcome brings about an increase in the supply of goods. The increase in prices and wages is reflected in consumer prices
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