Exchange rate pass-through to prices: the role of exchange rate uncertainty

This study reexamines exchange rate pass-through to prices using a state-dependent framework that allows the effects of exchange rate movements to vary asymmetrically across different regimes of exchange rate uncertainty. Empirical evidence for India reveals pronounced asymmetry in exchange rate pass-through. A 10% nominal depreciation above an upper threshold is associated with a price increase of approximately 3.37%, while a comparable real depreciation leads to a price increase of about 4.38%. Moreover, the coefficients on large nominal and real depreciations are negative and statistically significant across regimes, indicating that once depreciation exceeds a critical magnitude, its inflationary effect becomes regime-invariant. These findings remain robust across alternative measures of exchange rate volatility and econometric methodologies. This evidence suggests that successful anchoring of inflation depends on exchange rate stability, underscoring the importance of strategic exchange rate interventions as a complement to other conventional monetary policy measures that aim at price stability.