Exchange rate pass-through to price indices in Iran

Abstract

One of the major challenges for monetary policy is to predict how exchange rate fluctuations affect inflation and price indices. Hence, the main objective of this study is to examine the exchange rate fluctuation in the price indices in Iran. This paper analyzes the effects of exchange rate fluctuations on price indices and other macroeconomic variables of Iran during the period of 2004-Q1 to 2018-Q4, using the framework of a recursive VAR model, drawing on Bernanke (1986) and Sims (1986).The results indicate that the transfer of exchange rate changes to price indices is imperfect, such that the exchange rate path through to consumer, producer, and import prices is from 14.68%, 15.55% and 18.22% in the first period increase to 51.78%, 53.15% and 88.14% in the 13th period. In addition, the results indicate that the exchange rate path-through decreases along the distribution chain, with the highest exchange rate passing through the import prices, producer prices and consumer prices, respectively. The result has interesting implications for Iran’s ability to attain an effective inflation-targeting regime. Monetary policy makers should curb exchange rate fluctuations by adopting appropriate exchange rate policies in order to minimize the uncertainty of the consumer price index. The study contributes to the literature by assessing the effect of changes in the exchange rate (the Iranian Rial vis-à-vis the US$) on prices using an updated time series from 2004 to 2018. It addresses the limitations of the previous studies, which found no strong relationship between the exchange rate and inflation rate in the Iranian context. One of these limitations was using the CPI, as the only price index.