Pass-through of exchange rates to domestic prices:Case of Turkey

Exchange rate pass through is defined as the change in local currency import prices due to the exchange rate changes. Complete pass through refers to an equal proportional change between tradable good?s prices and exchange rate. The change in import prices is also likely to translate into changes in the producer and consumer prices of an economy if producers raise their prices in line with the increase in import prices. Exchange rate pass-through to domestic prices occurs via two channels which are direct and indirect effects. Since local currency prices of imported inputs and imports of finished goods will increase as a result of domestic currrency depreciation, the direct channel of pass-through states that, the increase in the subject local currency prices has an increasing effect on consumer prices. Meanwhile since demands for import substitute and export goods will increase as a result of domestic currrency depreciation, The indirect channel of exchange rate pass-through states that the increase in the subject demand has an increasing effect on wages and accordingly consumer prices. In this study, exchange rate pass through coefficients of domestic prices are estimated via Impulse Responce Functions that are obtained from VAR analysis established with monthly data of 1994-2001 and 2001-2006 sub-periods. According to results of this analysis; in the sub-preiod of 1994-2001, it is remarkable that exchange rate pass through coeeficients are high. In the subperiod of 2001-2006, a significant decrease in pass through coefficients has been determined so that completion time of pass-through gets longer. It is also determined that pass-through to producer prices is much higher compared to consumer prices for both sub-periods. In the period after 2001, weakening of direct channel of pass through due to adoption of floating exchange rate regime and come down of imported goods prices by overvaluation of Turkish Lira have an effect on decrease in pass-through