Exchange Rate Uncertainty and Connectedness of Inflation

Sadettin Haluk Citci () and Huseyin Kaya
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Sadettin Haluk Citci: Department of Economics, Gebze Technical University

No 2022-01, Working Papers from Gebze Technical University, Department of Economics

Abstract: In this study, we theoretically and empirically examine the connectedness of exchange rate uncertainty and inflation. In a small open economy setting with a flexible exchange rate and monopolistically competitive imported final goods sector, we show that price rigidities cause importers to carry exchange rate risk and they impose a premium for the risk they face by increasing consumer prices. This pricing behavior provides a channel between exchange rate uncertainty and overall price level. Then, we empirically analyze the impact of exchange rate uncertainty on inflation by using panel data from 149 countries over the period 19802017. The estimation results point that the uncertainty of the exchange rate has a significant and positive effect on inflation. Moreover, the degree of exchange rate pass-through and the effect of exchange rate uncertainty on inflation differ among country groups and their effects on inflation have decreased through time. We also show that the effect of exchange rate uncertainty on inflation is non-monotonic.

Keywords: exchange rate uncertainty; inflation; pricing power; exchange rate passthrough (search for similar items in EconPapers)
JEL-codes: E31 E52 F41 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2023-01-24
New Economics Papers: this item is included in nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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