Abstract
This article investigates the mechanism of exchange rate pass-through to the prices in the context of the Islamic Republic of Afghanistan’s economy. This study explored the magnitude and speed of the pass-through effect on the prices by analyzing quarterly data from 2003 Q1 to 2019 Q2 considering five variables (viz., world food price index, foreign reserves, money supply, import price, and nominal effective exchange rate) based on the Vector Autoregression Model (VAR) with the cointegration and innovation accounting tools such has impulse response function and variance decomposition. The findings of the study suggest that the exchange rate pass-through in Afghanistan is incomplete. The import price is highly responsive in the short-run and moderately responsive an increasingly smooth movement in the long-run. However, CPI in the short-run with swift positive respond but the long-run smooth increasing movement. Furthermore, variance decomposition evidence shows that import price is affected by FR, NEER, CPI, and MS in both short-run and long-run, but the CPI strongly lagged by its variance, WFP, NEER, import price, and MS.
Highlights
The Afghanistan’s national currency (Afghani) has been continuously experiencing gradual depreciation against foreign currencies, USD
The adjustment role of arbitrage transmitted the differences in inflation rates in concerning two countries through the relative exchange rate in the long run ―PPP postulate.‖ It means that the exchange rate pass-through theoretical depends on the doctrine of purchasing power parity
The Exchange rate is taken as one of the endogenous variable that react to economic policies because, in the floating exchange rate system, the exchange rate is not an influential factor of prices likewise it is effected by other factors such as inflation, money supply, demand shock, the price of the imported good and so on
Summary
The Afghanistan’s national currency (Afghani) has been continuously experiencing gradual depreciation against foreign currencies, USD. In spite of the fact that the monetary system, currency, was the benchmark of all economic reforms and restructuring of the economic system in the new era (Official Gazette, 808, 2003). At the end, it is awash in money. Many monetary and balance of payment models assumed one to one relationship between the exchange rate and domestic prices, but the findings of empirical studies have rejected the assumption unanimously, in the short run. The existence of the significant lags, in the transmission process of the exchange rate to domestic price, the effects of pass-through would be small. This study is decomposed into the literature review, an overview of the Afghan context, modeling, estimation of pass-through effects, empirical findings, suggestion, and the conclusion of the study
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