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Exchange Rate Pass-Through and Domestic Inflation: A Comparison between East Asia and Latin American Countries

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  • ITO Takatoshi
  • SATO Kiyotaka

Abstract

Currency crises, accompanied by large devaluation, tend to have significant impacts on the domestic economy. If the exchange rate also depreciates in real terms, the economy can take advantage of the export price competitiveness to promote its exports. In contrast, if the currency devaluation induces an increase in domestic inflation, the currency value in real terms will return toward the pre-crisis level, which results in a loss of the export price competitiveness and, hence, a slow recovery from the severe economic downturn. This paper analyzes the degree of domestic price responses to the exchange rate changes in crisis-hit countries in East Asian and Latina American countries and Turkey in order to reveal why the post-crisis inflation performance was very different across countries. The structural vector autoregression (VAR) technique is applied to examining exchange rate pass-through. The degree of exchange rate pass-through is found to be higher in Latin American countries and Turkey than in East Asian countries with a notable exception of Indonesia. In particular, Indonesia, Mexico, Turkey and, to a lesser extent, Argentina show a strong response of CPI to the exchange rate shock. More noteworthy is that excessive supply of base money played an important role in increasing the domestic inflation rate in Indonesia, while such effect is not observed in other countries, which indicates the importance of credible monetary policy committed to price stability in order to prevent the post-crisis inflation. Shock transmission from import prices or PPI to CPI is quite large in Indonesia, Mexico and Turkey. This finding implies that the channel of shocks at different stage of pricing chain may be an additional factor in high domestic inflation.

Suggested Citation

  • ITO Takatoshi & SATO Kiyotaka, 2007. "Exchange Rate Pass-Through and Domestic Inflation: A Comparison between East Asia and Latin American Countries," Discussion papers 07040, Research Institute of Economy, Trade and Industry (RIETI).
  • Handle: RePEc:eti:dpaper:07040
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    Cited by:

    1. Aleem, Abdul & Lahiani, Amine, 2014. "A threshold vector autoregression model of exchange rate pass-through in Mexico," Research in International Business and Finance, Elsevier, vol. 30(C), pages 24-33.
    2. Rucha R. Ranadive & L.G. Burange, 2015. "Transmission Mechanism of Exchange Rate Pass-through in India," Foreign Trade Review, , vol. 50(4), pages 263-283, November.
    3. Mirza, Nawazish & Naqvi, Bushra & Rizvi, Syed Kumail Abbas & Umar, Muhammad, 2023. "Fiscal or monetary? Efficacy of regulatory regimes and energy trilemma of the inflation reduction act (IRA)," International Review of Financial Analysis, Elsevier, vol. 90(C).
    4. Hernández, María Florencia, 2023. "Análisis del pass-through del tipo de cambio a la inflación en Argentina (2003-2020): un enfoque empírico," Nülan. Deposited Documents 4016, Universidad Nacional de Mar del Plata, Facultad de Ciencias Económicas y Sociales, Centro de Documentación.
    5. Beirne, John & Renzhi, Nuobu & Panthi, Pradeep, 2024. "Exchange rate pass-through in emerging Asia and exposure to external shocks," Economic Analysis and Policy, Elsevier, vol. 81(C), pages 1608-1624.
    6. Carranza, Luis & Galdon-Sanchez, Jose E. & Gomez-Biscarri, Javier, 2009. "Exchange rate and inflation dynamics in dollarized economies," Journal of Development Economics, Elsevier, vol. 89(1), pages 98-108, May.
    7. Montfaucon, Angella Faith & Sato, Kiyotaka & Shrestha, Nagendra & Parsons, Craig, 2021. "Exchange rate pass-through and invoicing currency choice between fixed and floating exchange rate regimes: Evidence from Malawi’s transaction-level data," Economic Analysis and Policy, Elsevier, vol. 72(C), pages 562-577.
    8. Naz, Farah & Mohsin, Asma & Zaman, Khalid, 2012. "Exchange rate pass-through in to inflation: New insights in to the cointegration relationship from Pakistan," Economic Modelling, Elsevier, vol. 29(6), pages 2205-2221.
    9. Fatma Marrakchi Charfi & Mohamed Kadria, 2016. "Incomplete Exchange Rate Pass-Through Transmission To Prices: An Svar Model For Tunisia," Annals of Financial Economics (AFE), World Scientific Publishing Co. Pte. Ltd., vol. 11(04), pages 1-23, December.
    10. Oluwasheyi Oladipo, 2017. "Inflation targeting and exchange rate pass-through to domestic prices: evidence from South Africa," Journal of Economic and Financial Studies (JEFS), LAR Center Press, vol. 5(5), pages 1-11, October.
    11. Oluwasheyi Oladipo, 2017. "The Effects of Inflation Targeting on Exchange Rate Pass-Through to Domestic Prices: A Case Study of South Africa," Advances in Management and Applied Economics, SCIENPRESS Ltd, vol. 7(6), pages 1-4.
    12. García-Solanes, José & Torrejón-Flores, Fernando, 2010. "Devaluation and pass-through in indebted and risky economies," International Review of Economics & Finance, Elsevier, vol. 19(1), pages 36-45, January.
    13. Baharumshah, Ahmad Zubaidi & Soon, Siew-Voon & Wohar, Mark E., 2017. "Markov-switching analysis of exchange rate pass-through: Perspective from Asian countries," International Review of Economics & Finance, Elsevier, vol. 51(C), pages 245-257.
    14. Brause, Alexander, 2008. "Foreign exchange interventions in emerging market countries: New lessons from Argentina," W.E.P. - Würzburg Economic Papers 79, University of Würzburg, Department of Economics.

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