Regime-dependent exchange-rate pass-through to import prices

Abstract

This paper investigates departures from linearity in the exchange rate pass-through (ERPT) to import prices of six major economies by using a logistic smooth transition pass-through (LSTP) regression. The analysis of LSTP regressions provides the following new insights into the dynamic features of ERPT: (i) There is strong evidence for the presence of smooth transition type threshold effects in the ERPT. The identified threshold dynamics reveals the existence of two extreme regimes, one with “low” and another with “high” pass-through. (ii) Both the short-run and the long-run pass-through estimates exhibit variation across these extreme regimes and in the long-run, pass-through tends to be complete in the “high” pass-through regime and low, but, incomplete in the “low” pass-through regime. (iii) Import price elasticities are asymmetric, as such, the same 1% depreciation of the currency is not associated with the same degree of ERPT across regimes. (iv) Temporal behavior of ERPT for a given country is generally similar across local currency appreciation and inflation rate-driven episodes. On the other hand, there is considerable variation across countries in the speed of the transitions and the estimated thresholds under each transition variable. These findings may explain why the linear ERPT literature might have obtained mixed results on the degree of ERPT across countries and sample periods used.