Inflation Rate and R/US$ Depreciation Shocks on Import Price Inflation: Inferences from Deviations from the 6 Per cent Inflation Rate

Abstract

The chapter examines whether different headline inflation bands propagates the response of import price inflation to import demand inflation shock. Evidence indicates that the cumulative propagating ability of inflation is much lower when inflation is below 6 per cent and particularly so when it is below 4.5 per cent. Levels above 6 per cent are bad for inflationary pressures. We assessed the asymmetric effects of inflation on import price inflation. Shocks to deviations from the 6 per cent reveals that big negative inflation shocks lead to larger decline in import price inflation than positive shocks of similar size. This evidence supports the role of low and stable inflation in mitigating the level of import prices inflation and the first stage of the exchange rate pass-through (ERPT) in supporting other macroeconomic policies.

In addition, the threshold beyond which inflation leads to different ERPT is 5.66 per cent and lies within the 3–6 per cent inflation target band. When inflation is below 4.5 per cent the propagation effects induced by headline inflation are very limited and almost diminished than when inflation is anywhere within the 3–6 per cent target band. This finding confirms that the level of inflation within the target range matters for the definition of what price stability means.