Exchange-rate pass-through to import prices in the euro area

Abstract

Introduction While exchange rate pass-through has long been of interest, the focus of this interest has evolved considerably over time. After a long period of debate over the law of one price and convergence across countries, beginning in the late 1980s exchange rate pass-through studies emphasised industrial organisation and the role of segmentation and price discrimination across geographically distinct product markets. More recently, pass-through issues play a central role in debates over appropriate monetary policies, exchange rate regime optimality in general equilibrium models and adjustment scenarios with respect to country external imbalances. These debates have broad implications for the conduct of monetary policy, for macroeconomic stability, international transmission of shocks and efforts to contain large imbalances in trade and international capital flows. Another issue receiving attention in the recent macroeconomic debate is the stability of exchange rate pass-through rates over time. Taylor (2000), Goldfajn and Werlang (2000), Campa and Goldberg (2005), and Frankel, Parsley and Wei (2005), have argued that pass-through rates may have been declining over time in some countries. The Brazilian experience of the late 1990s is often cited. Here, consumer prices hardly responded to large home currency depreciation, in sharp contrast with past depreciation episodes. Campa and Goldberg (2005) caution against the assumption that pass-through has been declining over time across all OECD countries. While some countries have experienced reduced transmission of exchange rate changes into import prices, much of their measured declines are due to a change in the composition of their import bundle towards goods with lower pass-through elasticities.

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