Monetary policy and exchange rate pass‐through

The pass‐through of exchange rate changes into domestic inflation appears to have declined in many countries since the 1980s. We develop a theoretical model that attributes the change in the rate of pass‐through to increased emphasis on inflation stabilization by many central banks. This hypothesis is tested on 20 industrial countries between 1971 and 2003. We find widespread evidence of a robust and statistically significant link between estimated rates of pass‐through and inflation variability. We also find evidence that observed monetary policy behaviour may be a factor in the declining rate of pass‐through. Published in 2004 by John Wiley & Sons, Ltd.