The Degree of Currency Substitution and Exchange Rate Pass-Through

This study investigates the effect of the degree of currency substitution on the exchange rate pass-through (ERPT) to import and domestic prices in Turkey, using monthly data between 1998 and 2013. The recursive interacted vector autoregressive (IVAR) specification of Towbin and Weber (2013) is employed, based on McCarthy’s (1999) distribution chain model. Currency substitution is treated as an interaction term in the IVAR specification. The empirical evidence suggests that high currency substitution increases the effect of ERPT to import and domestic prices.