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Forecasting Industry-Level CPI and PPI Inflation: Does Exchange Rate Pass-Through Matter?

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  • Dimitrios D. Thomakos
  • Prasad S. Bhattacharya

Abstract

In this paper, we examine whether industry-level forecasts of CPI and PPI inflation can be improved using the ``exchange rate pass-through" effect, that is, when one accounts for the variability of the exchange rate and import prices. An exchange rate depreciation leading to a higher level of pass-through to import prices implies greater expenditure switching, which should be manifested, possibly with a lag, in both producer and consumer prices. We build a forecasting model based on a two or three equation system involving CPI and PPI inflation where the effects of the exchange rate and import prices are taken into account. This setup also incorporates their dynamics, lagged correlations and appropriate restrictions suggested by the theory. We compare the performance of this model with a variety of unrestricted univariate and multivariate time series models, as well as with a model that, in addition, includes standard control variables for inflation, like interest rates and unemployment. Our results indicate that improvements on the forecast accuracy can be effected when one takes into account the possible pass-through effects of exchange rates and import prices on CPI and PPI inflation.

Suggested Citation

  • Dimitrios D. Thomakos & Prasad S. Bhattacharya, 2004. "Forecasting Industry-Level CPI and PPI Inflation: Does Exchange Rate Pass-Through Matter?," Econometric Society 2004 Australasian Meetings 293, Econometric Society.
    • Handle: RePEc:ecm:ausm04:293
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    More about this item

    Keywords

    Forecasting; Vector Autoregression; Non-linear Models; Inflation; Exchange Rates; Pass-Through Effect;
    All these keywords.

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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