Shocks versus Structure: Explaining Differences in Exchange Rate Pass-Through across Countries and Time

54 Pages Posted: 11 Jul 2017

See all articles by Kristin J. Forbes

Kristin J. Forbes

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Ida Hjortsoe

Bank of England

Tsvetelina Nenova

London Business School - Department of Economics

Date Written: June 30, 2017

Abstract

We show that exchange rate pass-through to consumer prices varies not only across countries, but also over time. Previous literature has highlighted the role of an economy’s ‘structure’ — such as its inflation volatility, inflation rate, use of foreign currency invoicing, and openness — in explaining these variations in pass-through. We use a sample of 26 advanced and emerging economies to show which of these structural variables are significant in explaining not only differences in pass-through across countries, but also over time. The ‘shocks’ leading to exchange rate movements can also explain variations in pass-through over time. For example, exchange rate movements caused by monetary policy shocks consistently correspond to significantly higher estimates of pass-through than those caused by demand shocks. The role of ‘shocks’ in driving pass-through over time can be as large as that of structural variables, and even larger for some countries. As a result, forecasts predicting how a given exchange rate movement will impact inflation at a specific point in time should take into account not just an economy’s ‘structure’, but also the ‘shocks’.

Keywords: Pass-Through, Exchange Rate, Price Level, Inflation, Monetary Policy

JEL Classification: E31, E37, E52, F47

Suggested Citation

Forbes, Kristin J. and Hjortsoe, Ida Maria and Nenova, Tsvetelina, Shocks versus Structure: Explaining Differences in Exchange Rate Pass-Through across Countries and Time (June 30, 2017). Bank of England Working Paper No. 50. Available at SSRN: https://ssrn.com/abstract=2999637 or http://dx.doi.org/10.2139/ssrn.2999637

Kristin J. Forbes

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

Room E62-416
Cambridge, MA 02142
United States
617-253-8996 (Phone)

HOME PAGE: http://web.mit.edu/kjforbes/www

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ida Maria Hjortsoe (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Tsvetelina Nenova

London Business School - Department of Economics ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

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