RDP 9304: Exchange Rate Pass-Through: The Different Responses of Importers and Exporters 1. Introduction

Devaluation increases the domestic price of traded goods and, other things being constant, increases the general price level. Thus, in the short run, currency depreciation is considered to be a source of inflationary pressure.^[1] However, the latest episode of currency depreciation in Australia has had a less-than-expected impact on inflation. This suggests that the extent to which changes in the exchange rate are transmitted to changes in the domestic prices of traded goods might be less than it was, say, a decade ago. If so, there are important implications for both the balance of payments and inflation. First, currency depreciation may be less effective in inducing those changes in relative prices that assist improvement of the balance of payments. Second, currency depreciation may have a lagged and uncertain impact on inflation.

This paper reviews the process by which changes in the exchange rate impact upon the domestic price of traded goods – that is, the pass-through effect. The main purpose of the paper is to estimate the dynamics of exchange rate pass-through with respect to the prices of imports and manufactured exports in Australia.^[2] It is hypothesised that there has been a change in the pass-through relationship during the 1980s. Furthermore, it is argued that the experience of exchange rate pass-through is significantly different for importers and exporters. The implications of this are discussed with respect to the balance of payments and inflation. In particular, an attempt is made to identify the inflationary consequences of the recent depreciation.

The paper is organised as follows. In section 2, recent trends in the exchange rate and inflation are discussed. In section 3, an analytical framework is developed which forms the basis of a model for testing the pass-through relationship. Features of the data required for estimation are discussed in section 4. Estimation and results are presented in section 5. In section 6, implications of the results are discussed. Finally, conclusions are drawn.

Footnotes

Though it is generally accepted that, in the long run, inflation is a monetary phenomenon. See Blundell-Wignall (1992) for a discussion of this view. [1]

That is, the pass-through relationship is being examined for similar classes of goods. The methodology for examining pass-through for commodities differs to that for manufactured goods (Heath 1991). [2]