Non-linearities in exchange rate pass-through: Evidence from smooth transition models

This paper examines the presence of non-linear mechanism in the exchange rate pass-through (ERPT) to CPI inflation for 12 euro area (EA) countries. Using smooth transition regression (STR) model, we explore the existence of non-linearities with respect to the inflation environment. We find strong evidence that pass-through respond non-linearly to inflation level for 8 out of 12 EA countries, that is, the transmission of exchange rate is higher when inflation rate surpass some threshold. Our results provide a broad support to the hypothesis suggested by Taylor (2000) that ERPT is decreasing in a lower and more stable inflation environment.