Exchange-rate pass through, openness, and the sacrifice ratio

Abstract

Considerable recent work has reached mixed conclusions about whether and how globalization affects the inflation-output trade-off and suggests that the ultimate effect of openness on the output-inflation relationship is influenced by a variety of factors. In this paper, we consider the impact of exchange-rate pass through and examine how pass through conditions the effect of openness on the sacrifice ratio. We develop a simple theoretical model showing how the extent of both pass through and openness can interact to influence the output-inflation relationship. Next we empirically explore the nature of these two variables and their interaction. Results indicate that greater pass through increases the sacrifice ratio, that there is statistically significant interaction between pass through and openness, andonce the extent of pass through is taken into account alongside other factors that affect the sacrifice ratio, such as central bank independence-openness fails to exert an empirically robust effect on the sacrifice ratio.

Implications of Globalization for the Output-inflation Relationship: an Assessment

“…They find evidence of a positive and statistically significant effect of an increased extent of pass through, which, as suggested by their theoretical model, is magnified by a greater degree of wage stickiness as proxied by union density. In contrast to their earlier studies, Daniels and VanHoose (2013) find evidence of a negative and statistically significant effect of openness on the sacrifice ratio-plus evidence that greater pass through reduces the absolute size of this negative effect. Consistent with Bowdler, Daniels and VanHoose (2013) find that the effects of central bank independence is diminished by taking into account exchange-ratebased influences on the interplay between openness and the outputinflation relationship.…”

“…These results, they suggest, offer support for their hypothesis that multifaceted aspects of increased globalization have mixed implications for the output-inflation relationship. Daniels and VanHoose (2013) build on the theory by incorporating a role for incomplete pass accessed by following the link in the citation at the bottom of the page. Review, Vol.…”

“…Consequently, there is less scope for increased openness simultaneously to yield consonant effects. Various authors have proposed potential roles for factors alongside globalization, including political regimes (Caporale and Caporale, 2008), costs of international trade and expenditure-switching effects (Cavelaars, 2009), exchangerate regimes (Bowdler, 2009), labor-market structures (Bowdler and Nunziata, 2010), and the extent of exchange-rate pass through (Daniels and VanHoose, 2013). Pickering and Valle (2012) provide another view on the effect of increased globalization on the output-inflation relationship.…”

“…To capture the impact of exchange-rate pass through, Pass Through, on the sacrifice ratio we use Campa and Goldberg's (2005) estimates of long-run exchange-rate pass through as employed by Daniels and VanHoose (2013). We also account for the exchange rate regime, Exchange Rate Regime, as suggested in accessed by following the link in the citation at the bottom of the page.…”

“…Models (7) and (8) consider the role of exchange-rate pass through as in Daniels and VanHoose (2013). The models differ in that Model (7) includes only the direct effect of Pass Through, while Model (8) includes the interaction of Pass Through and Openness.…”