Scandinavian Working Papers in Economics

Research Papers in Economics,
Stockholm University, Department of Economics

No 2017:1: Pass-through with low inflation and volatile exchange rates

Annika Alexius () and Mikaela Holmberg ()
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Annika Alexius: Dept. of Economics, Stockholm University, Postal: Department of Economics, Stockholm University, S-106 91 Stockholm, Sweden
Mikaela Holmberg: Dept. of Economics, Stockholm University, Postal: Department of Economics, Stockholm University, S-106 91 Stockholm, Sweden

Abstract: As central banks struggle to boost inflation rates in the face of low global inflation and volatile foreign exchange markets, it has become particularly important to understand how inflation in open economies is affected by movements in exchange rates and foreign inflation. Using a time-varying parameter Bayesian VAR, we analyze the behavior of pass-through across time and in relation to macroeconomic variables. We find little support for the Taylor (2000) hypothesis that pass-through is lower when inflation is close to target. In our data, inflation rates are often below rather than above target, and pass-through does not appear to increase significantly at low inflation rates. Furthermore, inflation persistence is unrelated to pass-through. The pass-through of foreign prices is much higher than the pass through of exchange rates. It is positively associated with the variance of foreign inflation, which is consistent with Calvo pricing.

Keywords: Pass through; inflation; Bayesian time varying parameter VAR

JEL-codes: E31; F41

46 pages, January 27, 2017

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