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Exchange Rate Pass Through Essay

2485 words - 10 pages

Literature review

Mongolian economy experienced relatively high inflation rate during the last two decades.
For the central bank it is crucial to find the important factor of the inflation. Among the researches by economists pointed out the relationship between inflation and exchange rate as a important factor of the inflation.
And economists more interested in the impact of exchange rate on inflation.
Many economists explain that due to the fall in import price during the Asian crises in industrialized countries leaded the deflation in the late 1990s. Especially in 1990s deflation in US and US is resulted from decline of exchange rate depreciation and import deflation.
And some analysts have pointed out that the greater openness of the country increases the exchange rate impact on inflation.
As Goldberg and Knetter [1997] suggested analysts started to focus on pass-through of an exchange fluctuations on domestic prices.
Since then, number of researchers studied exchange rate pass through on inflation in specific industry or macroeconomic pass through of specific country or group of countries depend on their general characteristics such as Woo 1984], Feinberg [1986; 1989], and Parsley and Popper [1998].
More narrowly, Campa and Goldberg [2005] estimated exchange rate pass through in more broader context in case of OECD countries. Choudhri, Faruqee, and Hakura [2005] found in their paper exchange rate pass through to import, consumer prices and producer for non-US G7 countries. However, paper didn’t extensively concentrate on monetary and real sector.
In this paper, I employ VAR model which allows to measure pass-through from exchange rate fluctuations to inflation in an integrated way.
Influences on pass through
In accordance with law of one price, change in exchange rate influence domestic prices. For the large economy, variation in the pass through of exchange rate fluctuations to inflation is more likely to be incomplete due to counteracting price change of the world. On the other hand in small open economies, inflationary effect of currency depreciation would be a complete because they don’t influence the world price.
Many studies examined that level of exchange rate pass through differs in across countries and industries within countries as well as throughout the periods.
One of the theoretical basic researches was done by Dornbusch (1987) and the paper applied the industrial organization model to explain price adjustment in terms of the degree of market concentration, relative market shares of imported and domestic products, and import penetration.
Based on industrial organization model, Feinberg (1989) empirically examined exchange rate pass through on domestic producer prices depending on its domestic industries in case of US and Germany between 1974 and 1987. In particular, paper found that higher pass through of exchange rate movement on domestic price in import oriented industries and lower pass through in capital...

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