Changing Exchange Rate Pass-Through in Japan: Does It Indicate Changing Pricing Behavior?

This paper empirically explores recent changes in the exchange rate pass-through in Japan. We take a two-pronged approach. First, we estimate the exchange rate pass-through into domestic prices using time-varying parameter estimation. Second, we decompose the estimated exchange rate pass-through into the responsiveness of marginal costs to the exchange rate and the responsiveness of inflation to marginal costs. The estimation results show that the rates of exchange rate pass-through into the Producer Price Index and the Consumer Price Index have been increasing since the late 2000s. Evidence from international input-output tables suggests that the import-intensity of Japan's manufacturing sector has increased considerably over the last decade. We find that although the increasing dependence on imports in production (as well as in the retail sector) accounts for part of the rise in exchange rate pass-through, a larger part of the rise is due to greater responsiveness of inflation to marginal costs. This finding hints at a structural change in firms' pricing behavior since the late 2000s.