Global Commodity Prices, Monetary Transmission, and Exchange Rate Pass-Through in the Pacific Islands
17 Pages Posted: 1 Nov 2012
Date Written: July 2012
Pacific Islands countries are vulnerable to commodity price shocks, and this poses challenges to monetary policy. The high degree of exchange rate pass-through to headline inflation and the weak monetary transmission mechanism in PICs suggest a greater efficacy of exchange rate changes in affecting inflation rather than monetary policy. To assess the tradeoff between the use of the exchange rate and monetary policy in macroeconomic stabilization, we employ a model-based approach to examine the optimal policy in response to the historical distribution of exogenous shocks in a Pacific Island (Tonga). The empirical evidence and model simulations tilt in the favor of exchange rate policy given the close relationship between exchange rate changes and headline inflation and the low interest rate sensitivity of aggregate demand.
Keywords: Commodity Prices, Exchange Rate Pass-through, And Monetary Policy, Economic Models, Exchange Rates, External Shocks, Monetary Transmission Mechanism, Pacific Island Countries
JEL Classification: E31, E52
Suggested Citation: Suggested Citation