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A New Look at Pass through Jay Shambaugh Dartmouth College Abstract This paper examines the relationship between exchange rates and prices Rather than assume exchange rate changes are exogenous shocks that affect prices I use a long run restrictions VAR to identify shocks and explore the way domestic prices import prices and exchange rates react to a variety of shocks Consumer price pass through is nearly complete in response to some shocks but low in response to others Alternatively import prices and exchange rates typically respond in the same direction and pass through seems quick This supports the idea that import prices are set in the producer s currency and that lower CPI pass through is a result of changes in quantities or margins further down the supply chain JEL Classifications F3 F4 E31 Keywords Exchange Rates Pass through Import Prices Inflation Vector Autoregression Jay C Shambaugh HB 6106 Economics Department Dartmouth College Hanover NH 03766 phone 603 646 9345 Fax 603 646 2122 email Jay C Shambaugh Dartmouth edu SECTION I Introduction The way the exchange rate interacts with the real economy depends critically on exchange rate passthrough the degree to which exchange rate changes are passed through to price level changes Our typical view of pass through notional pass through is one where the exchange rate changes for an exogenous reason and we see how prices change over time Given this view pass through plays a major role in determining the extent of exchange rate volatility the response of the terms of trade and trade balance to exchange rate changes and the optimal monetary policy and exchange rate regime When measured though pass through seems to vary both across countries and time and understanding the reasons for the different reactions of prices to exchange rate changes requires an examination of the root causes of exchange rate and price changes The wide variation in previously found pass through coefficients may in fact be nothing more than

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