Global Commodity Prices, Monetary Transmission, and Exchange Rate Pass-Through in the Pacific Islands
IMF Working Papers, July 1, 2012
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- Global Commodity Prices, Monetary Transmission, and Exchange Rate Pass-Through in the Pacific Islands
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Bibliographic details
- Authors: Shanaka J Peiris, Ding Ding
- Published: July 1, 2012
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475505245.001
Summary and key findings
- Pacific Islands countries (PICs) are vulnerable to commodity price shocks, posing challenges to monetary policy.
- There is a high degree of exchange rate pass-through to headline inflation in PICs.
- The monetary transmission mechanism in PICs is weak; aggregate demand shows low interest rate sensitivity.
- Empirical evidence and model simulations tilt in favor of exchange rate policy for macroeconomic stabilization given:
- the close relationship between exchange rate changes and headline inflation, and
- the low interest rate sensitivity of aggregate demand.
- The analysis focuses on a Pacific Island case (Tonga) to assess the tradeoff between the use of the exchange rate and monetary policy.
Methodology and scope
- A model-based approach is employed to examine the optimal policy response to the historical distribution of exogenous shocks in Tonga.
- The work combines empirical evidence with model simulations to evaluate policy effectiveness.
Policy implications and recommendations
- Exchange rate changes are more effective than conventional monetary policy in affecting headline inflation in PICs, given the observed high exchange rate pass-through and weak interest-rate transmission.
- Policy choice should account for the tradeoff between using the exchange rate versus monetary policy for macroeconomic stabilization, with results favoring exchange rate policy in the context examined.
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