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

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Executive Summary

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, the authors show that the dynamics of ERPT can be well-approximated by a class of Smooth Transition Auto Regressive (STAR) models with inflation as a transition variable. They 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.

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