Country and Time Variation in Exchange Rate Pass-Through: What Drives It?

Abstract

A large sample of developed and emerging economies is utilized to investigate import pass-through. Panel models reveal that various economic aspects of the destination country can explain about one third of the total variation in pass-through elasticities and the remaining variation comes largely in the form of unobserved country-specific effects. Inflation, exchange rate volatility, openness and relative wealth play a clear role as drivers of emerging markets' pass-through whereas the output gap and protectionism appear influential more generally. Nonlinearity regarding the differential impact of small and large exchange rate changes is quite pervasive. Our evidence challenges the widely-held view that pass-through has been universally falling in developed markets and that it is higher for emerging markets. A forecasting exercise confirms out-of-sample the predictive role of macro and micro factors. The findings confirm pricing-to-market theories and have implications for the optimal conduct of monetary policy.

Keywords: pass-through, exchange rate, asymmetry, prices, emerging markets, protectionism

JEL Classification: F10, F30, F14, F31