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Deep habits and exchange rate pass-through

Author

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  • Punnoose Jacob
  • Lenno Uuskula
Abstract
Habit persistence at the level of individual goods varieties can explain incomplete exchange rate pass-through to international prices. Deep habits give rise to a dynamic import demand function that leads to import price markup adjustments, independently of nominal pricing frictions. Augmenting a standard New Keynesian two-country model with deep habits, we obtain low exchange rate pass-through to import prices even when local currency prices are relatively flexible. As prices become more rigid, the presence of deep habits further reduces the pass-through of exchange rate fluctuations. Without deep habits, the model requires implausibly high degrees of price stickiness to match the pass-through dynamics triggered by an exchange rate shock in a vector autoregression.

Suggested Citation

  • Punnoose Jacob & Lenno Uuskula, 2016. "Deep habits and exchange rate pass-through," CAMA Working Papers 2016-17, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    • Handle: RePEc:een:camaaa:2016-17
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    Cited by:

    1. Dudley Cooke, 2019. "Consumer Search, Incomplete Exchange Rate Pass‐Through, and Optimal Interest Rate Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 51(2-3), pages 455-484, March.
    2. David Alaminos & M. Belén Salas & Manuel Á. Fernández-Gámez, 2023. "Quantum Monte Carlo simulations for estimating FOREX markets: a speculative attacks experience," Palgrave Communications, Palgrave Macmillan, vol. 10(1), pages 1-21, December.
    3. Jacob, Punnoose & Uusküla, Lenno, 2019. "Deep habits and exchange rate pass-through," Journal of Economic Dynamics and Control, Elsevier, vol. 105(C), pages 67-89.
    4. de Walque, Gregory & Lejeune, Thomas & Rannenberg, Ansgar & Wouters, Raf, 2023. "Low pass-through and international synchronization in general equilibrium: Reassessing vertical integration," Journal of International Economics, Elsevier, vol. 140(C).
    5. Okano, Mitsuhiro, 2021. "Optimal monetary policy in a two-country new Keynesian model with deep consumption habits," MPRA Paper 110259, University Library of Munich, Germany.
    6. Choi, Yoonho & Choi, E. Kwan, 2018. "Unemployment and optimal exchange rate in an open economy," Economic Modelling, Elsevier, vol. 69(C), pages 82-90.
    7. Aloui, Rym, 2024. "Habit formation and the government spending multiplier," Economic Modelling, Elsevier, vol. 132(C).
    8. Hasan, Syed & Shakur, Shamim & Breunig, Robert, 2021. "Exchange rates and expenditure of households with foreign-born members: Evidence from Australia," Journal of Economic Behavior & Organization, Elsevier, vol. 188(C), pages 977-997.

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    More about this item

    Keywords

    Exchange Rate Pass-through; Deep Habits; Sticky Prices; Price Markups; Local Currency Pricing;
    All these keywords.

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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