Has the Fiscal Policy Credibility Shock Impacted the Time-Varying Exchange Rate Pass-Through to Consumer Price Inflation?
Evidence indicates that the exchange rate pass-through (ERPT) to consumer price inflation declines more due to an unexpected improvement in the fiscal policy credibility in the low inflation regime compared to the high inflation regime. The decline in the ERPT is larger to the persistent improvements in fiscal policy credibility relative to those due to the transitory improvements in fiscal policy credibility. Evidence shows the decline in inflation expectations is amplified by the reduction of the ERPT to consumer price inflation following the fiscal policy credibility shocks. Thus, the ERPT plays a significant role in transmitting fiscal policy credibility shocks to inflation expectations. We conclude that improvements in fiscal policy credibility matter for the achievement of the price stability mandate and for the decline in the size of the ERPT to inflation.
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