The Effect of Exchange Rate on Inflation
THE EFFECTS OF EXCHANGE RATE IN INFLATION OUTPUT AND THE CURRENT ACCOUNT
ABSTRACT
The empirical studies on the effects of changes in exchange rates on inflation and real activity can be broadly divided into four categories:
Single-equation econometric methods,
Vector autoregressive (VAR) models,
Structural macro econometric models and DSGE models - Dynamic stochastic general equilibrium.
Methodologies:
First, most participants use single-equation econometric methods that estimate an exchange rate pass-through equation. The Bank of Israel, for example, estimates an open-economy version of a New Keynesian Phillips curve proposed by Svensson (2000), which relates inflation to expected inflation, the output gap, the exchange rate and import prices Bank of Israel summaries research at the Bank of Canada that typically used a Phillips curve to examine the impact of exchange rate movements on consumer prices. While most studies estimate pass-through equations with aggregated data, some recent papers also look at sectoral data, following the recent literature that has highlighted heterogeneous responses to exchange rate shocks across sectors. At the Bank of Italy, Bugamelli and Tedeschi (2004) estimate panel regressions with sectoral data. Several papers also estimate pass through for a panel of countries, example that by Bailliu and Fuji (2004) at the Bank of Canada. This line of research has produced a number of papers on euro-area countries. Some empirical studies have also focused on emerging market countries. Secondly, a number of papers use variants of the VAR models. Hahn (European Central Bank (2003)) estimates a VAR model with quarterly data to analyse the effect of exogenous shocks along the pricing chain. Kapur (Reserve Bank of India (2004)) estimates the impact of exchange rate changes in India using a small VAR with short-run restrictions. Work conducted at the Central Bank of Brazil also uses VAR techniques to trace the dynamic effect
ABSTRACT
The empirical studies on the effects of changes in exchange rates on inflation and real activity can be broadly divided into four categories:
Single-equation econometric methods,
Vector autoregressive (VAR) models,
Structural macro econometric models and DSGE models - Dynamic stochastic general equilibrium.
Methodologies:
First, most participants use single-equation econometric methods that estimate an exchange rate pass-through equation. The Bank of Israel, for example, estimates an open-economy version of a New Keynesian Phillips curve proposed by Svensson (2000), which relates inflation to expected inflation, the output gap, the exchange rate and import prices Bank of Israel summaries research at the Bank of Canada that typically used a Phillips curve to examine the impact of exchange rate movements on consumer prices. While most studies estimate pass-through equations with aggregated data, some recent papers also look at sectoral data, following the recent literature that has highlighted heterogeneous responses to exchange rate shocks across sectors. At the Bank of Italy, Bugamelli and Tedeschi (2004) estimate panel regressions with sectoral data. Several papers also estimate pass through for a panel of countries, example that by Bailliu and Fuji (2004) at the Bank of Canada. This line of research has produced a number of papers on euro-area countries. Some empirical studies have also focused on emerging market countries. Secondly, a number of papers use variants of the VAR models. Hahn (European Central Bank (2003)) estimates a VAR model with quarterly data to analyse the effect of exogenous shocks along the pricing chain. Kapur (Reserve Bank of India (2004)) estimates the impact of exchange rate changes in India using a small VAR with short-run restrictions. Work conducted at the Central Bank of Brazil also uses VAR techniques to trace the dynamic effect
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