Monetary Policy Credibility and the Time-Varying Exchange Rate Pass-Through to Consumer Price Inflation
This chapter examines, the extent to which monetary policy credibility impacts the time varying exchange rate pass-through (ERPT) to consumer price inflation. We establish that the correlation between the growth of nominal effective exchange rate (NEER) and inflation has declined or weakened over time. In addition, the ability of the exchange rate to explain movements in inflation has weakened over time. The repo rate tightening shock lowers the ERPT and the correlation between the NEER changes and inflation. Evidence shows that the decline in ERPT is due to improved credibility of monetary policy conduct and keeping inflation within the 3–6% band. This concurs with the Taylor (European Econ Rev 44:1389–1408, 2000) hypothesis which links declines in ERPT and low inflation environment.
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