Exchange Rate Pass-Through to Consumer Prices: The Increasing Role of Energy Prices
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Exchange Rate Pass-Through to Consumer Prices: The Increasing Role of Energy Prices Hyeongwoo Kim1 · Ying Lin2 · Henry Thompson3
© Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract A number of researchers have found that the rate of exchange rate pass-through (ERPT) to domestic prices has declined substantially over the last few decades. We revisit this claim of a shrinking exchange rate effect on the Consumer Price Index (CPI) in a vector autoregressive (VAR) model for US macroeconomic data under the current floating exchange rate regime. Our VAR approach nests the conventional single equation method and reveals statistically significant evidence of ERPT to the CPI only during later observations, sharply contrasting with previous findings. After confirming structural breaks in ERPT via statistical tests by Hansen (Journal of Economic Perspectives, 15(4), 117–128, 2001) and Qu and Perron (Econometrica, 75(2), 459–502, 2007), we seek the source with disaggregated level CPIs, and pin down a key role of energy prices. US energy imports increased from the 1990s until the recent recession. This market changes magnify the effects of the exchange rate shocks on domestic energy prices, resulting in greater responses of the total CPI via the energy price channel. Keywords Exchange rate pass through · Disaggregated CPI inflation · Structural break · Real exchange rate shock JEL Classification E31 · F31 · F41 Ying Lin
[email protected] Hyeongwoo Kim [email protected] Henry Thompson [email protected] 1
Auburn University, 138 Miller Hall, Auburn, AL 36849, USA
2
School of Economics and Finance, Xi’an Jiaotong University, Xi’an, 710061, People’s Republic of China
3
Auburn University, 125 Miller Hall, Auburn, AL 36849, USA
H. Kim et al.
1 Introduction In an open economy, changes in the exchange rate can substantially influence the Consumer Price Index (CPI). In response to depreciations of the home currency, import prices may rise, triggering increases in the CPI of the home country. In addition, the relative demand for domestic products may grow through the expenditure switching effect when the home currency loses value against the foreign currency, making home products relatively cheaper. Stronger demand for domestic goods then raises home consumer prices. Rates of exchange rate pass-through (ERPT) to the CPI may change over time. Frankel et al. (2012), for instance, provide international evidence that the degree of ERPT to import goods prices, and in turn to the CPI, decreased during the 1990s especially in developing countries. Campa and Goldberg (2005) report similar evidence for 23 high-income OECD countries. Taylor (2000) claims that weaker degree ERPT to the CPI of the US in the 1990s is due to a lower inflationary environment. Gagnon and Ihrig (2004) extended Taylor’s claim to 11 industrialized countries. Takhtamanova (2010) presents similar empirical evidence of structural breaks in the rate of ERPT during the 1990s for a set of fourteen OECD countries. We revisit this clai
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