Exchange Rate Pass-Through and Inflation:A Nonlinear Time Series Analysis

Abstract

This paper investigates the relationship between the exchange rate pass-through (ERPT) and inflation by estimating a nonlinear time series model. Using a simple theoretical model of ERPT determination, we show that the dynamics of ERPT can be well-approximated by a class of smooth transition autoregressive (STAR) models with inflation as a transition variable. We employ several U-shaped transition functions in the estimation of the time-varying ERPT to U.S. domestic prices. The estimation result suggests that declines in the ERPT during the 1980s and 1990s are associated with lowered inflation.