Nonlinear exchange rate transmission in the euro area: A multivariate smooth transition regression approach

Publication Type:
Journal Article
Economics Bulletin, 2018, 38 (3), pp. 1590 - 1602
Issue Date:
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© 2018, Economics Bulletin. This paper examines the presence of nonlinear behavior in the exchange rate pass-through (ERPT) for a set of euro area countries. We propose to solve the endogeneity problem inherent in single-equation-based methods by implementing the family of nonlinear vector smooth transition regression (VSTR) models. Using quarterly data that span from 1980:1 to 2015:4, linearity tests reveal that the ERPT responds nonlinearly to economic growth. According to the pass-through elasticities, exchange rate transmission differs significantly between the identified economic activity regimes. However, our results underscore the presence of heterogeneous profiles across the euro area economies. For some countries, the ERPT is higher during expansions than during recessions; however, the result is reversed for others. Our findings emphasize the role of a declining ERPT, as it may foster business cycle synchronization and inflation convergence within the monetary union.
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