The Shocks Matter: Improving our Estimates of Exchange Rate Pass-Through

Hjortsø, Ida, Kristin Forbes and Tsvetelina Nenova
Authors registered in the RePEc Author Service: Ida Hjortsoe

No 13037, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: A major challenge for monetary policy is predicting how exchange rate movements will impact inflation. We propose a new focus: directly incorporating the underlying shocks that cause exchange rate fluctuations when evaluating how these fluctuations “pass through†to import and consumer prices. A standard open-economy model shows that the relationship between exchange rates and prices depends on the shocks which cause the exchange rate to move. We build on this to develop a structural Vector Autoregression (SVAR) framework for a small open economy and apply it to the UK. We show that prices respond differently to exchange rate movements based on what caused the movements. For example, exchange rate pass-through is low in response to domestic demand shocks and relatively high in response to domestic monetary policy shocks. This framework can improve our ability to estimate how pass-through can change over short periods of time. For example, it can explain why sterling’s post-crisis depreciation caused a sharper increase in prices than expected, while the effect of sterling’s 2013-15 appreciation was more muted. We also apply this framework to forecast the extent of pass-through from sterling’s sharp depreciation corresponding to the UK’s vote to leave the European Union.

Keywords: Exchange rate pass-through; Import prices; Consumer prices; inflation; Vector autoregressions (search for similar items in EconPapers)
JEL-codes: E31 F3 F41 (search for similar items in EconPapers)
Date: 2018-07
New Economics Papers: this item is included in nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (202)

Downloads: (external link)
https://cepr.org/publications/DP13037 (application/pdf)

Related works:
Journal Article: The shocks matter: Improving our estimates of exchange rate pass-through (2018)
Working Paper: The Shocks Matter: Improving Our Estimates of Exchange Rate Pass-Through (2018)
Working Paper: The shocks matter: improving our estimates of exchange rate pass-through (2015)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:13037

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP13037

Access Statistics for this paper

More papers in CEPR Discussion Papers from Centre for Economic Policy Research 33 Great Sutton Street, London EC1V 0DX, UK.
Bibliographic data for series maintained by CEPR ().