Rand/US Dollar Exchange Rate Pass-Through and the Inflation Environment

Abstract

This chapter establishes an inflation threshold that leads to a source of non-linearity in the exchange rate pass-through (ERPT). Findings establish that the ERPT is high when the R/US$ exchange rate depreciates at the time when inflation exceeds the threshold. This suggests that the R/US$ exchange rate depreciation is a significant driver of inflation, especially in episodes when inflation is above the threshold. Furthermore, the inflation regime has an impact on the persistence of the R/US$ exchange rate depreciation shock and inflation persistence. The half-life of the R/US$ exchange rate depreciation shocks in the higher inflation regime is double that in the lower inflation regime. The policy implication of the results is that the inflation threshold around 4 per cent carries economic and welfare benefits in many ways. The pass-through is lower below this threshold and the existing inflationary environment plays a central role.