Pass-Through of Exchange Rates to Domestic Prices in East European Countries and the Role of Economic Enviroment

4/2004

Abstract
The paper examines the exchange rate pass-through in a set of 13 East European countries during the period of 1993-2003. The pass-through estimates are derived from a recursive VAR model in first differences, and the impact of exchange rate changes on both the producer and the consumer prices is studied. The estimates obtained for two sub-sample periods generally show an incomplete pass-through over a two-year horizon. In addition, the results imply a considerable cross-country variation and suggest that a significant decline (by nearly 50%) in the pass-through is possible over time. In particular, it is found that the exchange rate pass-through in East European countries is positively and statistically significantly related to the average inflation rate and the degree of exchange rate persistence. Moreover, the results confirm the existence of strong relationship between the pass-through and changes of the import structure. Finally, there is some limited evidence that the magnitude of the exchange rate pass-through might be positively related to the degree of openness to foreign trade of a country.

Key words: pass-through of exchange rate, recursive VAR model, Exchange Rate Mechanism II

JEL classification codes: C32, E31, E52