Working Paper: CEPR ID: DP8153
Authors: Janine Aron; Greg Farrell; John Muellbauer; Peter Sinclair
Abstract: Understanding how import prices adjust to exchange rates helps anticipate inflation effects and monetary policy responses. This paper examines exchange rate passthrough to the monthly import price index in South Africa during 1980-2009. A methodological innovation allows various short-run pass-through estimates to be calculated simply without recourse to a full structural model, yet without neglecting the long-run relationships between prices or the effects of previous import price changes, and controlling for domestic as well as foreign costs. Pass-through is incomplete at about 50 percent within a year and 30 percent in six months, averaging over the sample. Johansen analysis of a cointegrated system using impulse response functions largely supports these short-run results, but as it includes feedback effects, implies lower pass-through for exogenous exchange rate shocks. Equilibrium pass-through, ignoring feedback effects, is around 75 percent. Shifts in pass-through with trade and capital account liberalisation in the 1990s are explored. There is evidence of slower pass-through under inflation targeting when account is taken of temporary shifts to foreign currency invoicing or increased hedging after large exchange rate shocks in the period. Further, pass-through is found to decline with recent exchange rate volatility and there is evidence for asymmetry, with greater pass-though occurring for small appreciations.
Keywords: Asymmetric passthrough; Exchange rate passthrough; Exchange rate volatility; Falling passthrough; Import prices; Monetary policy; South Africa; Trade openness
JEL Codes: C22; C32; C51; C52; E3; E52; F13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| exchange rate changes (F31) | import prices (P22) |
| exchange rate changes (F31) | incomplete passthrough to import prices (F16) |
| trade and capital account liberalization (F32) | shifts in passthrough (H22) |
| inflation targeting (E31) | slower passthrough (F16) |
| exchange rate volatility (F31) | decline in passthrough (H29) |
| small appreciations (Y60) | greater passthrough (H22) |
| large exchange rate shocks (F31) | increased hedging (G41) |