Literature review
Mongolian economy experienced relatively high inflation rate during the last two decades.
For the central bank it is crucial to find the important factor of the inflation. Among the researches by economists pointed out the relationship between inflation and exchange rate as a important factor of the inflation.
And economists more interested in the impact of exchange rate on inflation.
Many economists explain that due to the fall in import price during the Asian crises in industrialized countries leaded the deflation in the late 1990s. Especially in 1990s deflation in US and US is resulted from decline of exchange rate depreciation and import deflation.
And some analysts have pointed out that the greater openness of the country increases the exchange rate impact on inflation.
As Goldberg and Knetter [1997] suggested analysts started to focus on pass-through of an exchange fluctuations on domestic prices.
Since then, number of researchers studied exchange rate pass through on inflation in specific industry or macroeconomic pass through of specific country or group of countries depend on their general characteristics such as Woo 1984], Feinberg [1986; 1989], and Parsley and Popper [1998].
More narrowly, Campa and Goldberg [2005] estimated exchange rate pass through in more broader context in case of OECD countries. Choudhri, Faruqee, and Hakura [2005] found in their paper exchange rate pass through to import, consumer prices and producer for non-US G7 countries. However, paper didn’t extensively concentrate on monetary and real sector.
In this paper, I employ VAR model which allows to measure pass-through from exchange rate fluctuations to inflation in an integrated way.
Influences on pass through
In acc...
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... Import share of consumption and inputs in production leads the higher pass through. Hence, countries or industries with high degree of openness tend to have greater exchange rate pass through.
4. Import structure: Pass through varies among the importing industries. Energy and raw material industries tend to have more pass through than manufactured products. (Jeevan Kumar (2007))
5. International trade barriers (tariffs and quantitative restrictions): The barriers allow the arbitrage opportunities for international trade and affect pass through to be low
6. Opportunity cost: More specifically, menu cost affects the pass through.
7. Asymmetry effect: Pass through differs depending on exchange rate appreciation or depreciation.
8. Miscellaneous factors such as income transportation costs. The higher the income and transportation cost the lower the pass through.
Meade (1988) stated that, because of the exchange rate rapid decline so much since early 1985 in the US and because the monthly trade statistics has been examined so thoroughly for any sign of a turnaround in the nominal trade balance, the J-curve phenomenon has received much attention. The statistics often implies that the negative effect of depreciation is reflected in the J-curve as the continuation of nominal trade deficit. Between early 1985 and 1988, the exchange value of US dollar in terms of currencies of other countries, registered a sizeable depreciation. The deficits recorded in the trade account were mirrored in the current account deficit. Meade depicted the significance of the exchange rate to the trade account as well as current account through the use of the J-curve highlighting that the phenomenon is used as a long-term goal to curb the deficits, however in the short-run, depreciation will increase the nominal deficits accumulated by a country.
Foreign exchange is a commodity, and its price fluctuates based on supply and demand, like any commodity. This is not the place for a complete discussion of supply and demand as relates to foreign exchange, but for our purposes, we will assume that supply of and demand for a country’s currency moves along with the supply of or demand for that country’s products or the products of its trading partners. For example, if one country buys many more goods from its neighbor than its neighbor buys from it, the balance of payments at the end of the year will cause its neighbor’s currency to be in great demand, thereby driving its price up.
...such methods have led not only to intervallic spikes of high inflation, disastrous devaluations and financial troubles, but also to enduringly elevated nominal and real interest rates. The possibility of devaluation precludes integration into the global financial markets. The power to devalue has not catapulted exports over the longer term. Actually, it is just the opposite. It has seen to locking developing nations into low valued-added products exposed to wide and unpredictable price shifts. The country of El Salvador calculated the pros and cons of having domestic currency through two consecutive administrations and, ultimately, made the choice to dollarize based on their critical examination. Some countries may discover it practical to conduct their own analysis, and others may find it valuable to embrace the monetary services provided by the dollar global economy.
...y Fixed Exchange Rates: Recent Experiences." Introduction to International Economics. New York: Palgrave Macmillan, 2011. 368. Print.
However, we found that rice is an inferior good in which an increase in income leads to lower consumption. The main idea behind the gravity model is that countries with larger economies tend to trade more, while distance represents a proxy for transportation costs and higher distance should lead to lower bilateral trade. Indeed, Ariccia (1999) found that exchange rate volatility has a negative impact on international trade. Another paper for consideration is Tenreyro (2004) which tests the effect of nominal exchange rate on trade by using the gravity model to explain the phenomenon. However, the author adds importer and exporter specific effects (s_i and s_j) to account for multilateral resistance and concludes that two countries that peg their currency to the same anchor experience a lower level of exchange rate fluctuation. Lastly, Aristotelous (2001) tests exchange rate volatility and trade volume by using the gravity model in the same context as Bergstrand (1989) with the dummy variable of w_t equal to one if world war one and zero if world war two and where D_1 is the managed float exchange rate regime dummy that is equal to one when a managed float regime is in effect. The author finds that exchange rate volatility has no effect on British
The stability of currency values plays a significant role for economic and financial stability. It is not difficult to see the exchange rate fluctuations are widely regarded as damaging. As the movements of the exchange rate have significant and large effects on the trade balance, resource allocation, domestic prices, interest rate, national income and other key economic variables. Then can exchange rate movements be predicted by these fundamental economic variables?
“For many years it has been believed that if countries import more than they export and so have a deficit on the current account of the balance of payments then their currencies will tend to fall in value. Yet over the last two years the dollar has been a strong currency even though USA has had a record current account deficit. How can this fact be explained? What does it tell us about the factors, which determine exchange rates? What policy decisions with regard to exchange rates do you think USA and other governments should take in response to these developments?”
In addition, value of exchange rate will affect the cost of imports and exports. MNCs involved in many import and export activities, volatility of exchange rate will bring the positive or negative effects to the firms. In the exchange rate, the relationship of currency between the countries is opposite. For example, domestic currency appreciation causes the import cheaper. On the other hand, foreign currency appreciation causes the import expensive.
Williamson, R. (2001). ‘‘Exchange rate exposure and competition: evidence from the automotive industry,’’ Journal of Financial Economics, Vol. 59, pp. 441-75
(Holden, Holden , & Suss, 1979) said that inflation has less impact on exchange rate. Countries have their own monetary policy, differences trading relations and productivity movements. Therefore, countries adjust their exchange rate to fulfill the needs of their trade partner by controlling the inflation rate. The beta coefficient results in this research shows inflation rates implies in exchange rate have a strong relationship where the beta coefficient is 0.3676. There are positive relationships between inflation and exchange rate as the coefficient sign is positive.
The forward method uses purchasing power parity (PPP) method where the only consideration is the inflation rates between the two countries (Taylor, 2003). This approach depends on the theoretical law that identical goods will cost the same in different countries excluding the after taking into consideration the exchange rates and excluding the transaction and shipping cost. Based on this, the PPP approach forecasts changes in exchange rates to offset price changes due to inflation only.
There is one thing that differentiates the international business with the domestic business where it uses more than one currency in the commercial transaction. For example, if a company from British purchases some goods from a company from US, the international transaction will require for exchanging pounds and U.S. dollars which involve the foreign exchange market. In the foreign exchange market, any country that wish to do business with foreign country, the country need to convert their domestic currency into the foreign currency that they are wish to cooperate with through foreign exchange.
Daily in the USA about 38 million banknotes of various face value for total amount about 541 million dollars are issued (Facts about USA money).Dollars involve deep consequences both for the USA, and for other countries. Increase of its course relatively reduces the volume of export revenue in dollars, quite often involves more considerable, than change of an exchange rate, falling of the world prices, especially on raw materials. On the contrary, decrease in a dollar rate serves as the powerful tool promoting growth of the American export and a pushing off of competitors of the USA in foreign markets. At the same time import to the USA owing to effect of a rise in prices restrains. Thus, for the USA changes in the exchange rate of dollar anyway bring benefits and advantages.Reduction of leading positions of the USA in world economy is assisted by the international role of dollar which remains the main reserve and settlement means in world monetary system. Foreign currency reserves of the central banks of other countries for 61% consist of dollars, nearly 2/3 calculations in world trade are carried out in dollars; the dollar serves as a measure of value of many important goods (for example: oil) in the world market; in dollars 3/4 international bank crediting is made (Aleksandr Popov). Changes in the exchange rate of dollar involve deep consequences both for the USA, and for other countries. Increase of its course relatively reduces the volume of export revenue in dollars, quite often involves more considerable, than change of an exchange rate, falling of the world prices, especially on raw materials. On the contrary, decrease in a dollar rate serves as the powerful tool promoting growth of the American export and a pushing off...
Ignatiuk, A., 2008. The Principle, Practise and Problems of Purchasing Power Parity Theory. 1st ed. Norderstedt: BoD – Books on Demand.
There are many factors that affect the economy, inflation is one of them. Basically inflation is risingin priceof general goods and services above a period.As we see value of money is not valuable for the next years due to inflation. Today every country has facing inflationary condition in their economy.GDP deflator is a basictool that tells the price level of final goods and services domestically produced in an economy.GDP is stand for gross domestic product final value of goods and services, Furthermore GDP deflator shows that how much a change in the base year's GDP relies upon changes in the price level. . Inflation in contrast, how speedy the average prices intensity is increases or changes above the period so the inflation rate define the annual percentage rate changes in the level of price is as measure by GDP deflator more over GDP deflator has a advantage on consumer price index because it isn’t only based on a fixed basket of goods and services. It’s a most effective inflation tool to identify the changes in consumer consumption and newly produced goods and service are reflected by this deflator. Consumer price index (CPI) is also measure the adjusting the economic data it can also be eliminate the effects of inflation, through dividing a nominal quantity by price index to state the real quantity in term.