Exchange rate pass-through in a Small Open Economy
Year: 2005
Type: preprint
Abstract: :\nSeveral small open economies switched to inflation targeting during the 1990s, thereby giving up\nvarious forms of exchange rate targeting in favour of flexible exchange rates. Norway did the same\nearly in 2001, and has thereafter experienced highly varying nominal exchange rates with consumer\nprice inflation dropping far below the target during 2003 and 2004. Knowledge of the degree of\nexchange rate pass-through to import prices and further to consumer prices is essential for inflation\ntargeting. The literature suggests that pass-through is greater to import prices than to consumer\nprices, which presumably is related to the role of distributors in the economy. We present empirical\nevidence on these issues for Norway by estimating import price equations and a dynamic model of\nthe distributors pricing behaviour. Using a large-scale macroeconometric model of the Norwegian\neconomy, we find exchange rate pass-through to import prices to be quite rapid in the short run,\nwhile pass-through to consumer prices seems to be modest. We show that, among the numerous\nchannels through which the exchange rate operate, trade margins in the distribution sector act as\ncushions to exchange rate fluctuations, thereby being one of the main important source for the delay\nin pass-through. In spite of moderate pass-through to consumer prices, we find inflationary effects of\nexchange rate changes even in the short run, an insight important for inflation targeting central\nbanks.\nKeywords: Exchange rate pass-through, pricing behaviour, the distribution sector, econometric\nmodelling and macroeconomic analysis
Authors: Pål Boug, Ådne Cappelen, Torbjørn Eika
Language: English
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W2247309537