The effects of exchange rate pass-through and cost channel on price level: The case of fragile five countries

ABSTRACT

In this study, we investigated whether the exchange rate and the interest rate had an effect on the inflation rate in the fragile five countries between the years of 1996Q4 and 2015Q4. In this context, a model was created to estimate the effect of interest rate and exchange rate on the inflation rate. The methods used in the study take into account cross-section dependence and heterogeneity. As a result of the analysis, it was determined that there was an exchange-rate and interest-rate pass-through effect in the fragile five countries. Moreover, it was found out that the cost channel and price puzzle were effective in Indonesia and South Africa but were not effective in Turkey, Brasil and India.

KEYWORDS:

• Pass-through effect
• cost channel
• price puzzle
• fragile five
• common correlated effects mean group estimator

JEL CLASSIFICATION:

• B22
• C33

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ Morgan Stanley (2013) made this classification in the August economy report. Turkey, Brazil, India, Indonesia and South Africa are among this group, which is called the fragile five. The reasons that these countries are identified as the fragile five are: high current account deficits, high inflation rates and declining growth performance. In addition to these common features, political uncertainty in these countries increases the risks. A substantial number of developing countries is struggling with high inflation. The results of an analysis of the fragile five countries at high risk for fighting inflation have been thought to be important for developing countries as well.

² Fragile five countries have implemented inflation-targeting regime since the beginning of the 2000s. See the following web address to learn the list of the countries implemented the inflation-targeting regimes..

³ The results of the panel unit root test for I(1) series are available upon request.

⁴ See Doğan et al. 2016, Incekara, Demez, and Ustaoğlu 2012; Sathye, Sharma, and Liu 2009; Aktham and Haitham 2006; Berument and Jelassi 2002 for the definition of Fisher hypothesis and validity of Fisher hypothesis in Turkey, Brasil and India.