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The Endogeneity of Exchange Rate Pass-Through: Some European Evidence

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Abstract

The decline in exchange rate pass-through (ERPT) in the last three decades is well-documented in the literature. Various studies seek explanations, among which is higher monetary policy credibility. ERPT is often treated as exogenous (i.e., fix coefficient) in policy-makers’ and market participants’ forecasting models. However, if the ERPT is endogenous to monetary policy, it can lead to an error in inflation forecasts and inaccurate policy reaction. Against this backdrop, this paper seeks to examine the endogeneity of exchange rate pass-through to monetary policy, using the European countries as the sample.

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Notes

  1. Existing studies identify several factors, such as a change trade structures (Gust et al. 2010; Campa and Goldberg 2002), the declined exchange rate variability (Choudhri and Hakuta 2001; Sekine 2006; Frankel et al. 2004), and increased competition due to globalization (Rogoff 2003; IMF 2006; McCarthy 1999).

  2. De Haan et al. (2005) provide a useful literature survey of the ERPT in the context of the Eurozone.

  3. Corsetti and Pesenti (2002) and Devereux et al. (2003) study theoretically how monetary policy or exchange rate regime would affect export price pass-through.

  4. Bernanke (2004). Structural changes and globalization are also being considered to have played a role in lower ERPT.

  5. In reaction to the euro implementation, Hall and Lagoa (2014) find that inflation quickly converged since mid-2002 among the EMU economies.

  6. Difference-in-difference approach is normally used for household and firm-level data, and not country-level data. See for example Card and Krueger (1994) for difference-in-difference approach on the store-level.

  7. T-statistics (H0: there is no difference in the mean) was not rejected at 10 % significance level.

  8. Mellens et al. (2007).

  9. Levin et al. (2002)

  10. Im, et al. (2003)

  11. According to the Hausman’s test using pooled OLS and IV estimate, we could not reject the H0 that exchange rate is endogenous at 1 % significance level.

  12. Hsiao et al. (2012) used a Lagragian multiplier (LM) to test for cross-section independence

  13. See Eberhardt, M., and Teal, F (2008) for further detailed descriptions.

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Correspondence to Ayako Saiki.

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Economist, Ayako Saiki, De Nederlandsche Bank

The author would like to thank anonymous referees, Jeffrey Frankel, Jan Marc Berk, Jakob De Haan, Eiji Fujii, Gabriele Galati, Chen Zhou, Andreas Pick and Pierre Lafourcade for their useful inputs. In addition, the author would like to thank Markus Eberhardt for his generous help with STATA code. Martin Admiraal and Rene Bierdrager provided excellent research assistance. All remaining errors are mine. The views expressed in this article do not necessarily reflect the views of DNB or the Eurosystem.

Appendix

Appendix

Table 6 Pair-wise comparison of EMU and non-EMU economies

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Saiki, A. The Endogeneity of Exchange Rate Pass-Through: Some European Evidence. Open Econ Rev 26, 893–909 (2015). https://doi.org/10.1007/s11079-015-9344-1

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