On the Pass-Through of Exchange Rate Fluctuations to the Macroeconomy: Imports in Developing and Advanced Countries (Digest Summary)

The author considers the effect of exchange rate fluctuations on import fluctuations and the implication of the changes in both variables for macroeconomic conditions. Exchange rate fluctuations are decomposed into an anticipated shift, positive shocks, and negative shocks. Variations in import growth in particular help to explain the effect of exchange rate fluctuations on the macroeconomy. The author treats advanced and developing economies separately and shows that the reaction to exchange rate shocks differs significantly between the two groups of countries.

The author establishes a number of empirical facts about the effects of exchange rate fluctuations on imports and the overall macroeconomic performance in advanced and emerging economies. First, the tendency for depreciation of the real exchange rate is more pronounced in advanced economies than in developing economies because of the comparably higher inflation rates in developing economies. At the same time, the variability of exchange rates is lower in developing economies because of their greater reliance on stabilizing interventions in currency markets.

Second, anticipated exchange rate depreciation (appreciation) increases (decreases) price inflation and import growth in developing economies. The cost of imports is importantly linked to fluctuations in the real economy. Depreciation increases the cost of imports and inflation, whereas appreciation decreases the cost of imports and stimulates growth. In contrast, there is no clearly identifiable transmission mechanism between exchange rate fluctuations and macroeconomic activity via the cost of imports in advanced economies. Instead, terms of trade shocks that are independent of exchange rate shifts are important for macroeconomic fluctuations in advanced countries.

Third, in both advanced and developing economies, the import channel appears to be more relevant than the exchange rate channel for macroeconomic performance. Finally, because of the relatively high stability of the exchange rate, import variability is not linked significantly to exchange rate variability in developing economies. In contrast, the variability of imports increases significantly with exchange rate variability across advanced economies. But import variability still dominates exchange rate variability as a transmission channel to broad macroeconomic activity.

The author bases her empirical work on a theoretical model for real output and inflation. Both variables are assumed to react to domestic demand shocks, energy price shocks, and exchange rate shocks. These exchange rate shocks are symmetrically distributed around an anticipated trend and decomposed into negative (unanticipated depreciation) and positive (unanticipated appreciation) deviations. Because exchange rate fluctuations are probably transmitted to growth and inflation via imports, the reaction of imports to demand shocks, energy price shocks, and exchange rate shocks is also estimated.

Annual data from 1978 to 2008 are used to create a sample of 19 developing and 26 advanced economies. The dependent variables of interest are real growth, price inflation, consumption growth, investment growth, export growth, and import growth.

To understand the differences in the reaction to exchange rate shifts between developing and advanced economies, the author conducts several econometric tests. First, the responses of the dependent variables to anticipated changes in and positive and negative shocks to the exchange rate are estimated. Second, cross-country correlations reveal co-movements of consumption, investments, and imports in reaction to exchange rate shifts. These shifts are broken down into three components: anticipated appreciation, appreciation shocks, and depreciation shocks. Third, import shifts are substituted for exchange rate shifts in time-series regressions to test for the effects of the import channel on the macroeconomy. Fourth, cross-country regressions are used to test the impact of exchange rate movements and import growth on real growth, price inflation, private consumption, and investment. Finally, cross-country regressions are used to test the impact of exchange rate variability and the variability of imports on the variability of real growth, price inflation, private consumption, and investment.

The author conducts a thorough empirical analysis that covers a long time period and a large number of countries. Her main contribution is the insight that exchange rate fluctuations are frequently transmitted to the macroeconomy via the import channel. This insight deserves further attention and analysis, possibly against the background of different theoretical model structures.