Is low inflation really causing the decline in exchange rate pass-through?

Recent literature has argued that exchange rate pass-through (ERPT) into domestic inflation has been declining in many countries following a dramatic change in inflation environment during the 1990s. Available empirical results face two central challenges: (i) the evidence on declining ERPT is mostly based on sample-splitting approaches and hence subject to a degree of arbitrariness; and (ii) the link between a lower ERPT and inflation environment is usually based on simple correlation analysis and hence silent about temporal causality. We address these issues by making use of a state-space model that allows ERPT to be time-varying and dependent on the inflation environment. -- exchange rate pass-through ; inflation ; state-space models ; causality tests