Degree Of Exchange Rate Pass-through Research Articles

Pass-Through of Exchange Rate into Domestic Prices: The Case of Four East-Asian Countries

The paper undertakes a comparative empirical analysis of the effects of shocks on domestic prices in four Asian countries before and after the financial crisis of 1997 in South-East Asia. We apply two different estimation methodologies, namely structural VAR and a single equation approach. The results of the two methods are consistent, although the magnitude of the elasticities of the exchange rate pass-through are different due to the inclusion of different variables, lag terms and different assumptions made in both methods. The results show that the degrees of exchange rate pass-through in these countries are different across countries and over time. In most cases, the pass-through rates are incomplete. The degree of exchange rate pass-through is highest on import prices, moderate on PPI and lowest on CPI. In some cases, the pass-through rates on CPI are even negative. The effect of the import price shock is stronger compared to that of the exchange rate shock in determining the movement of domestic prices in these countries. Trade openness has a weak correlation with the degree of exchange rate pass-through.

Import Price Dynamics in Major Advanced Economies and Heterogeneity in Exchange Rate Pass-Through

This paper aims at showing heterogeneity in the degree of exchange rate pass-through to import prices in major advanced economies at three different levels: 1) across destination markets; 2) across types of exporters (distinguishing developed economy from emerging economy exporters); and 3) over time. Based on monthly data over the period 1991-2007, the results show first that large destination markets exhibit the lowest degree of pass-through. The degree of pass-through for goods imported from emerging economies is also significantly lower than for those from developed economies. Regarding the evolution over time, no clear change in pricing behaviours can be identified and particular events, like large exchange rates depreciations during the Asian crisis, seem to influence the degree of pass-through related to imports from emerging economies.

A Comparative Analysis of Export Price Pass-through in Three Open Asian Economies: Korea, Singapore and Thailand

The degree of exchange rate pass-through is of paramount importance to small and open economies as it has a direct impact on domestic inflation as well as the effectiveness of exchange rate as an adjustment tool. High exchange rate pass-through (ERPT) is often cited as a reason for a “fear of floating”. This article analyzes the degree of ERPT into the export prices of three Asian economies—Korea, Thailand and Singapore for the period 1980: Q1–2006: Q4 using both US dollar bilateral rates as well as nominal effective exchange rates. The study also examines whether there are asymmetries in ERPT between exchange rate appreciation and depreciation.

How high is exchange rate pass-through in India? Has it changed over time?

Concerns about relatively high degrees of exchange rate pass-through in a number of emerging economies have contributed to a fear of floating. Despite the obvious policy relevance of this issue there is hardly any existing literature that has examined aggregate CPI pass-through for India, which has been liberalizing its economy since 1991. This paper estimates exchange rate pass-through (ERPT) at the aggregate level into India's CPI for the period 1980Q1 – 2005Q3. We also analyze whether exchange rate pass-through in India has changed over time, particular since 1991, which was the beginning of the country's economic liberalization program.

Exchange Rate Pass-Through in ASEAN: Implications for the Prospects of Monetary Integration in the Region

This paper investigates, for the first time, the degree of exchange rate pass-through to domestic prices in all five founding members of ASEAN. For this purpose, a three variable recursive VAR model was applied which uses the Choleski decomposition method along the distribution chain of pricing, using data for the period 1968 to 2001. The results show that a strong case for entering a currency union can only be made for the cases of Singapore and Malaysia as in these countries there appears to be a case of exchange rate disconnect. A case for a common currency can also be made for Indonesia but for entirely different reasons. For this country, an independent monetary policy is a clear source of shocks to the economy and therefore a currency union would tend to eliminate then. A weaker case for a common currency can be made for the Philippines as evidence of some exchange rate pass-through to inflation was found but not to import prices. Finally, Thailand exhibits a clear case of exchange rate pass-through to import prices (but not to inflation) and thus evidence that a flexible exchange rate might be preferable as it provides the means to improve the country's price competitiveness.

Exchange Rate Pass-Through in Emerging Markets

This paper examines the degree of Exchange Rate Pass-Through (ERPT) to prices in 12 markets in Asia, Latin America, and Central and Eastern Europe. Our results, based on three alternative vector autoregressive models, partly overturn the conventional wisdom that ERPT into both import and consumer prices is always higher in emerging than in countries. For markets with only one digit inflation (most notably the Asian countries), passthrough to import and consumer prices is found to be low and not very dissimilar from the levels of developed economies. The paper also finds robust evidence for a positive relationship between the degree of the ERPT and inflation, in line with Taylor's hypothesis once two outlier countries (Argentina and Turkey) are excluded from the analysis. Finally, the presence of a positive link between import openness and ERPT, while plausible theoretically, finds only weak empirical support.

Interest Rate Rules, Endogenous Cycles, and Chaotic Dynamics in Open Economies

In this paper we present an extensive analysis of the consequences for global equilibrium determinacy of implementing active interest rate rules (i.e. monetary rules where the nominal interest rate responds more than proportionally to changes in inflation) in flexible-price open economies. We show that conditions under which these rules generate aggregate instability by inducing cyclical and chaotic equilibrium dynamics depend on particular characteristics of open economies such as the degree of (trade) openness and the degree of exchange rate pass-through implied by the presence of non-traded distribution costs. For instance, we find that a forward-looking rule is more prone to induce endogenous cyclical and chaotic dynamics the more open the economy and the higher the degree of exchange rate pass-through. The existence of these dynamics and their dependence on the degree of openness are in general robust to different timings of the rule (forward-looking versus contemporaneous rules), to the use of alternative measures of inflation in the rule (CPI versus Core inflation), as well as to changes in the timing of real money balances in liquidity services ("cash-when-I-am-done" timing versus "cash-in-advance" timing).

Exchange rate pass-through in the U.S. automobile market: A cointegration approach

This study analyzes exchange rate pass-through in the presence of monopolistic competition in the U.S. automobile market. Using cointegration techniques, we investigate how foreign competing firms' prices interact following an exchange rate-shock. The results generally indicate price interdependence (competition) among the rival firms. In one case where we did not find any price interdependence, the extent of exchange rate pass-through was higher. This validates the economic intuition that a low degree of price competition corresponds with a high degree of exchange rate pass-through.

International Dimensions of Optimal Monetary Policy

This paper provides a baseline general-equilibrium model of optimal monetary policy among interdependent economies with monopolistic firms that set prices one period in advance. Strict adherence to inward-looking policy objectives such as the stabilization of domestic output cannot be optimal when firms' markups are exposed to currency fluctuations. Such policies induce excessive volatility in exchange rates and foreign sales revenue, leading exporters to set higher prices in response to higher profit risk. In general, optimal rules trade off a larger domestic output gap against lower import prices. Monetary rules in a world Nash equilibrium lead to less exchange rate volatility relative to both inward-looking rules and discretionary policies, even when the latter do not suffer from any inflationary (or deflationary) bias. Gains from international monetary cooperation are related in an nonmonotonic way to the degree of exchange rate pass-through.

International dimensions of optimal monetary policy

This paper provides a baseline general equilibrium model of optimal monetary policy among interdependent economies with monopolistic firms and nominal rigidities. An inward-looking policy of domestic price stabilization is not optimal when firms’ markups are exposed to currency fluctuations. Such a policy raises exchange rate volatility, leading foreign exporters to charge higher prices vis-à-vis increased uncertainty in the export market. As higher import prices reduce the purchasing power of domestic consumers, optimal monetary rules trade off a larger domestic output gap against lower consumer prices. Optimal rules in a world Nash equilibrium lead to less exchange rate volatility relative to both inward-looking rules and discretionary policies, even when the latter do not suffer from any inflationary (or deflationary) bias. Gains from international monetary cooperation are related in a non-monotonic way to the degree of exchange rate pass-through.

The Role of Domestic and Foreign Investors in a Simple Model of Speculative Attacks

We introduce local and foreign investors in a simple model of speculative attacks. Local investors have less tolerance for overvaluation of the fixed exchange rate because they tend to incur lower costs when taking a short position and possess better information, and because of moral hazard created by discriminatory government guarantees. On the other hand, the prospect of higher taxation after a balance of payments crisis deters speculation by locals compared to foreign investors. Finally, the lower the degree of exchange rate pass-through, the more likely domestic investors are tp take the lead during capital flight.

Market Power, Innovative Activity and Exchange Rate Pass-Through

This paper considers an international oligopoly where firms simultaneously choose both the amount of output produced and the proportion of R&D investment to output. The model captures the links between the exchange rate, market power, innovative activity and price, which are important for the determination of the optimal degree of exchange rate pass-through. It is found that in the long run the pass-through elasticity can be less than, equal to or greater than one depending on R&D effectiveness but in any case it is higher than in models that do not endogenise innovation decisions. The empirical implications of the model are tested using data for Japanese firms exporting to the US market and applying the Johansen multivariate cointegration technique. Particular attention is given to the estimation and identification of the equilibrium price and R&D-intensity equations. The empirical results indicate that price-setting and R&D-intensity decisions of firms are jointly determined in the long run. This interdependence must be taken into account if an accurate estimate of the exchange rate pass-through is to be obtained.

The Role of Domestic and Foreign Investors in a Simple Model of Speculative Attacks

We introduce local and foreign investors in a simple model of speculative attacks. Local investors have less tolerance for overvaluation of the fixed exchange rate because they tend to incur lower costs when taking a short position and possess better information, and because of moral hazard created by discriminatory government guarantees. On the other hand, the prospect of higher taxation after a balance of payments crisis deters speculation by locals compared to foreign investors. Finally, the lower the degree of exchange rate pass-through, the more likely domestic investors are tp take the lead during capital flight.

Exchange rate pass-through in the Netherlands: has it changed?

This study assesses whether the degree of exchange rate pass-through in the Netherlands has changed during the run-up to Economic and Monetary Union. VAR models are estimated on rolling sample periods to show that the pass-through of changes in the guilder-mark exchange rate has increased, while the pass-through of changes in the guilder-pound and guilder-dollar have remained more or less stable. This supports the view that the Netherlands and Germany have become increasingly integrated. This is in contrast to Taylor's (Economic Review 44, 1384–408, 2000) claim that the decline in inflation has been associated with a significant decline in the degree to which firms pass-through changes in costs.

Interest Rate Rules and Multiple Equilibria in the Small Open Economy

In a small open economy model with traded and non-traded goods this paper characterizes conditions under which interest rate rules induce aggregate instability by generating multiple equilibria. These conditions depend not only on how aggressively the rule responds to inflation, but also on the measure of inflation to which the government responds, on the degree of openness of the economy and on the degree of exchange rate pass-through. As an important policy implication, this paper finds that to avoid aggregate instability in the economy the government should implement an aggressive rule with respect to the inflation rate of the sector that has sticky prices. That is the non-traded goods inflation rate. As a by-product of this analysis, it is shown that fear-of-floating governments that follow a rule that responds to both the CPI-inflation rate and the nominal depreciation rate or governments that implement super-inertial interest rate smoothing rules may actually induce multiple equilibria in their economies. This paper also shows that for forward-looking rules, the determinacy of equilibrium conditions depends not only on the degree of openness of the economy but also on the weight that the government puts on expected future CPI-inflation rates. In fact rules that are excessively forward-looking always lead to multiple equilibria.

Exchange Rate Pass-Through in the Deflationary Japan: How Effective is the Yen's Depreciation for Fighting Deflation?

There is an increasing endorsement for the yen's depreciation as a means to fight the ongoing deflation in Japan. The idea of generating inflation via depreciation relies on the assumption that exporters pass-through most of the effect of the exchange rate changes to the Japanese importers and consumers. A recent study by Taylor (2000), however, suggests that the rate of the pass-through may have declined in many countries making depreciation of domestic currencies less inflationary. In this study, we estimate the degree of exchange rate pass-through to the Japanese imports, focusing on the recent deflationary period. We then assess quantitatively the expected effectiveness of depreciation in taming the deflation. Our empirical results indicate that the long-run import pass-through has indeed declined significantly. As a result, the inflationary effect of depreciation has been reduced substantially over the past two decades.

Interest Rate Rules and Multiple Equilibria in the Small Open Economy

In a small open economy model with traded and non-traded goods this paper characterizes conditions under which interest rate rules induce aggregate instability by generating multiple equilibria. These conditions depend not only on how aggressively the rule responds to inflation, but also on the measure of inflation to which the government responds, on the degree of openness of the economy and on the degree of exchange rate pass-through. As an important policy implication, this paper finds that to avoid aggregate instability in the economy the government should implement an aggressive rule with respect to the inflation rate of the sector that has sticky prices. That is the non-traded goods inflation rate. As a by-product of this analysis, it is shown that "fear-of-floating" governments that follow a rule that responds to both the CPI-inflation rate and the nominal depreciation rate or governments that implement "super-inertial" interest rate smoothing rules may actually induce multiple equilibria in their economies. This paper also shows that for forward-looking rules, the determinacy of equilibrium conditions depends not only on the degree of openness of the economy but also on the weight that the government puts on expected future CPI-inflation rates. In fact rules that are "excessively" forward-looking always lead to multiple equilibria.

EXCHANGE RATE PASS-THROUGH FOR SELECTED ASIAN ECONOMIES

This paper investigates the degree of exchange rate pass-through for the selected Asian countries namely Malaysia, Thailand, Taiwan, and Singapore. Unlike past studies, this paper focuses on small open economies and includes exports of primary commodities in the investigation. We utilize cointegration techniques based on Engle and Granger (1987) and Johansen and Juselius (1990), and error correction modeling, to provide a more robust and rigorous investigation of the long run and short run pass-through of exchange rates. It is found that, in general, the degree of pass-through is high, although there is a small extent of pricing to market found for all countries. For Malaysia, the degree of pricing to market found suggests that there is intense competition in the export industries. In the case of Thailand, there is almost complete pass-through and this conforms to our a priori expectations. In the case of Singapore and Taiwan, we detect a higher degree of pass-through compared to past studies. For a country, the high degree of pass-through will support the adoption of more flexible exchange rate oriented monetary policies, and for firms it will reveal the limits of their price setting behavior amidst international competition.

Exchange Rates and Monetary Policy in Emerging Market Economies

We compare alternative monetary policies for an emerging market economy that experiences external shocks to interest rates and the terms of trade. Financial frictions magnify volatility but do not affect the ranking of alternative policy rules. In contrast, the degree of exchange rate pass-through is critical for the assessment of monetary rules. With high pass-through, stabilising the exchange rate involves a trade-off between real stability and inflation stability and the best monetary policy rule is to stabilise non-traded goods prices. With delayed pass-through, the trade-off disappears and the best monetary policy rule is CPI price stability.

The Scope for Exchange Rate Passthrough in a Duopolistic Supergame

This paper represents one of the first analyses of exchange rate passthrough in a dynamic context. It explores the impact of exchange rate fluctuations in a duopoly where the firms interact over an indefinite period. In these circumstances there exists an incentive for the duopolists to tacitly collude. The paper investigates the manner in which exchange rate changes influence the inherent tension that exists between the incentives to collude and compete. It is shown that the sign and degree of exchange rate passthrough depends critically upon the expected duration of a change in the exchange rate and the relative competitive strengths of the firms. The predictions of the model closely accord with the empirical evidence on exchange rate passthrough.