The oil price-inflation nexus: The exchange rate pass- through effect

Abstract

Crude oil prices have been considered one of the key drivers of inflation worldwide, reaching a peak in 2022. Inflation targeting plays a pivotal role in such a high inflation episode. In this vein, the exchange rate is a key channel in transmitting the high commodity price into the domestic price level, known as the exchange rate pass-through effect. On this basis, this paper scrutinizes the connection between oil prices and inflation through RMB exchange rates. We verify that the covariance between exchange rates and oil prices are sound factors in explaining and predicting inflation in China. We advocate that policymakers can use the exchange rate as an inflation stabilizer by reducing the covariance between the exchange rate and oil price, especially for emerging economies and during the turmoil periods. This could be extremely helpful to frustrate the exchange rate pass-through effect of high commodity prices globally, which sheds new insights into stabilizing inflation and assisting inflation targeting for emerging economies.