A panel cointegration analysis of the exchange rate pass-through

This paper investigates the presence of a long-run equilibrium relationship in the exchange rate pass-through (ERPT) equation for a panel of 27 OECD countries. Previous empirical panel data studies, such as Barhoumi [2005, "Exchange rate pass-through into import prices in developing countries: An empirical investigation", Economics Bulletin, Vol. 3 (26), 1–14.], have neglected the possibility of cross-sectional correlation and spillovers amongst countries. Since the strong economic and financial linkages between OECD countries cannot be ignored, we apply second generation panel unit root and panel cointegration tests which account for possible cross-section dependence across the units in the panel. Our results suggest the existence of a cointegrated equilibrium relationship between the variables in levels, as implied by the theoretical underpinning of the ERPT mechanism. When estimating the long-run pass-through coefficient, both FM-OLS and DOLS estimators show an incomplete pass-through, i.e. import prices sensitivity to exchange rate movements does not exceed 0.70% for our sample of OECD countries. This evidence of partial pass-through would represent a key element in understanding the ongoing global external imbalances.