Modelling exchange rate pass-through: A model of oil prices and asymmetric exchange rate fluctuations

Abstract

Orientation: The literature on exchange rate pass-through appears to have shifted from the question of whether the pass-through is complete or incomplete to whether or not it is sufficient to assume that the pass-through is exogenous despite the vulnerability of exchange rates to shocks because of other external prices.

Research purpose: The primary objective of this study is to examine the role of oil prices in the dynamics of exchange rate pass-through to domestic inflation in net oil-exporting and oil-importing countries.

Motivation for the study: Motivated by the increasing evidence of significant responses of exchange rates to changes in oil prices, this study hypothesises that changes in oil prices matter for the degree and direction of exchange rate pass-through in the context of oil-importing and oil-exporting dichotomy. This study attempts to re-define the areas of ambiguities on the exchange rate, and other accompanying factors linked to it for clarity.

Research approach/design and method: Using a macro panel data set, we explore the newly formulated non-linear panel autoregressive distributed lag model to account for asymmetries in our assessment of the role of oil prices in the degree and direction of pass-through of the exchange rate. Thus, in addition to reflecting the pass-through in a nonlinear form, this study also accounts for heterogeneity as well as non-stationarity. Besides, we also evaluate the role of prices in the pass-through of exchange rates symmetrically using the symmetric version of the Panel ARDL model.

Main findings: Given the data under consideration, our empirical findings give credence to the school of thought challenging the widely held assertion that the declining pass-through of the exchange rate is mainly caused by the phenomenon of the developed market.

Practical/managerial implications: We also find that accounting for asymmetries in the pass-through matters for the extent to which changes in oil prices accelerate the degree of pass-through.

Contribution/value-add: This study finds evidence of an insignificant role of oil prices in the pass-through of the exchange rate fluctuations to inflation. Once the pass-through is captured asymmetrically, it becomes evident that changes in oil prices matter in the pass-through.