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Nonlinearities in the exchange rate pass-through: The role of inflation expectations

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  • Anderl, Christina
  • Caporale, Guglielmo Maria
Abstract
This paper investigates nonlinearities in the exchange rate pass-through (ERPT) to consumer and import prices by estimating a smooth transition regression model with different inflation expectations regimes for five inflation targeting countries (the UK, Canada, Australia, New Zealand and Sweden) and three non-targeters (the US, the Euro-Area and Switzerland) respectively over the period January 1993–August 2021. Both market and survey measures of inflation expectations are used as the transition variable, and the nonlinear model is also assessed against a benchmark linear model. The pass-through to both consumer and import prices is found to be stronger in the nonlinear model and in some cases is close to being complete. Also, it is stronger in regime 2, i.e., when markets and consumers expect high inflation rates in the future; this suggests that anchoring inflation expectations helps to reduce the ERPT. Finally, inflation expectations appear to affect the ERPT more in inflation targeting countries.

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  • Anderl, Christina & Caporale, Guglielmo Maria, 2023. "Nonlinearities in the exchange rate pass-through: The role of inflation expectations," International Economics, Elsevier, vol. 173(C), pages 86-101.
    • Handle: RePEc:eee:inteco:v:173:y:2023:i:c:p:86-101
    DOI: 10.1016/j.inteco.2022.10.003
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    More about this item

    Keywords

    Exchange rate pass-through; Smooth transition regression; Nonlinearities; Inflation expectations;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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