Measuring Exchange Rate Pass-Through under Structural Changes: The Case of Turkey

Abstract

In this paper we aim to analyze the pass-through from exchange rate to domestic inflation for Turkey covering the period 1986:1-2009:10. As a novelty, the quantitative analysis of the exchange rate pass-through is investigated by the regime dependent impulse response functions based on a Markov Regime Switching Vector Autoregressive (MS-VAR) model. Using this nonlinear technique, we compute different impulse response functions for the different phases of the economy. This allows us to test the validity of the hypothesis of Taylor (2000) suggesting that low inflationary environment itself lowers the pass-through. Our analysis provides an empirical support for the proposition of Taylor (2000). The exchange rate pass-through is weaker and slower in the low inflation regime. Our findings indicate that change in the inflation expectations with the successful implementation of inflation targeting policy is a potential reason for the declining exchange rate pass-through.