Large Exchange Rate Shocks and Nonlinear Effects in Exchange Rate Pass-Through
| Title: |
Large Exchange Rate Shocks and Nonlinear Effects in Exchange Rate Pass-Through |
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Number: |
25/05 |
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Author(s): |
Fethi Öğünç, Orhun Özel |
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Language: |
Turkish |
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Date: |
April 2025 |
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Abstract: |
Based on observations over the last five years, this paper argues that there are non-linear effects in exchange rate pass-through to consumer prices. The exchange rate pass-through to prices differs in periods of moderate and large depreciations, as a result of the state-dependent pricing behavior in firms' price-setting decisions. According to our findings, the pass-through from shocks to inflation is higher in periods of large exchange rate shocks. In these periods, inflation increases more than what is normally observed, but in the following months, inflation decelerates more rapidly than predicted by linear models. The results suggest that an asymmetric relationship defined over the size of exchange rate changes in shock periods is a good explanatory variable for modeling these effects in periods of large exchange rate shocks. In a period of moderate shocks, the long-run exchange rate pass-through is estimated to be around 38-40 percent. When large shock period-specific effects are not included in the models, there is a risk of overestimating the extent of exchange rate pass-through. Models that do not incorporate non-linear relationships diverge from normal period dynamics when attempting to explain large shock periods, resulting in a decline in the explanatory power. The results indicate that movements specific to large shock periods should be taken into account in inflation modeling processes | |
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Keywords: |
Exchange rate pass-through, Non-linear effects, State-dependent pricing behavior, Asymmetric effect, Inflation modeling | |
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JEL Codes: |
C52; E31; E37 | |