Working Paper: CEPR ID: DP15242
Authors: Kristin Forbes; Ida Hjortsoe; Tsvetelina Nenova
Abstract: We analyse the economic conditions (the “shocks”) behind currency movements and show how that analysis can help address a range of questions, focusing on exchange rate pass-through to prices. We build on a methodology previously developed for the United Kingdom and adapt this framework so that it can be applied to a diverse sample of countries using widely available data. The paper provides three examples of how this enriched methodology can be used to provide insights on pass-through and other questions. First, it shows that exchange rate movements caused by monetary policy shocks consistently correspond to significantly higher pass-through than those caused by demand shocks in a cross-section of countries, confirming earlier results for the UK. Second, it shows that the underlying shocks (especially monetary policy shocks) are particularly important for understanding the time-series dimension of pass-through, while the standard structural variables highlighted in previous literature are most important for the cross-section dimension. Finally, the paper explores how the methodology can be used to shed light on the effects of monetary policy and the debate on "currency wars": it shows that the role of monetary policy shocks in driving the exchange rate has increased moderately since the global financial crisis in advanced economies.
Keywords: passthrough; exchange rate; price level; inflation; monetary policy; currency wars
JEL Codes: E31; E37; E52; F47
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary policy shocks (E39) | higher passthrough to consumer prices (E31) |
| demand shocks (E39) | lower passthrough to consumer prices (E31) |
| underlying shocks (E32) | understanding the time-series dimension of passthrough (C22) |
| monetary policy shocks (E39) | increase in role in driving exchange rate movements (F31) |
| monetary policy shocks (E39) | no higher exchange rate volatility (F31) |