Forbes, Kristin. <br/><br/>
The Shocks Matter:  Improving Our Estimates of Exchange Rate Pass-Through / 
Kristin Forbes, Ida Hjortsoe, Tsvetelina Nenova. 
 - Cambridge, Mass.  National Bureau of Economic Research  2018. 
 - 1 online resource:  illustrations (black and white); 
 - NBER working paper series  no. w24773 .
 - Working Paper Series (National Bureau of Economic Research)  no. w24773. .
<br/><br/> June 2018. 
<br/><br/> A major challenge for monetary policy is predicting how exchange rate movements will impact inflation.  We propose a new focus: directly incorporating the underlying shocks that cause exchange rate fluctuations when evaluating how these fluctuations "pass through" to import and consumer prices. A standard open-economy model shows that the relationship between exchange rates and prices depends on the shocks which cause the exchange rate to move. We build on this to develop a structural Vector Autoregression (SVAR) framework for a small open economy and apply it to the UK. We show that prices respond differently to exchange rate movements based on what caused the movements. For example, exchange rate pass-through is low in response to domestic demand shocks and relatively high in response to domestic monetary policy shocks. This framework can improve our ability to estimate how pass-through can change over short periods of time. For example, it can explain why sterling's post-crisis depreciation caused a sharper increase in prices than expected, while the effect of sterling's 2013-15 appreciation was more muted. We also apply this framework to forecast the extent of pass-through from sterling's sharp depreciation corresponding to the UK's vote to leave the European Union. 
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