Exchange rate Pass-Through to domestic prices in Tunisia: a short and long run analysis

This study analyzes the impact of the exchange rate fluctuations in the short and long-runs in Tunisia under a pure commitment policy through two channels. The first is the Structural Vector Autoregression used to analyze the short run effects of the exchange rate on the industrial production index and on the consumer and import price indexes. The second is the Vector Error Correction Model used to examine the long run dynamic effects of the exchange rate upon the same variables relying on Tunisian monthly data during the period January 1993 to June 2011. Unlike several empirical studies, which show that the impact of the exchange rate movements on prices has been reduced over the past few years in the industrialized countries, the exchange rate is found to be a potential source not only of production but also of inflation reduction in Tunisia. Indeed, the direct channel of the exchange rate seems to have a significant impact on production and inflation in the long-run, whereas the indirect one has no effect on the money supply. These results strongly support the monetary policy of the central bank targeting the exchange rate because there is a strong correlation between this rate and prices.