Transmission Channels from the Exchange Rate to the Consumer Price Index: The Tradable Component of the CPI by Industry

02/08/2015 |  Orfaig (Flikier) Dana
All Press Releases In Subject:
Monetary Policy and Inflation

The transmission from the exchange rate to prices is a main component of the
transmission mechanisms from monetary policy’s tools to its objectives, and is
therefore important in formulating monetary policy. Previous studies have attempted
to analyze and understand the transmission by estimating inflation equations or,
alternatively, have divided the Consumer Price Index into tradable and nontradable
components through methods that are not based on quantitative data. This study
proposes a precise calculation of the CPI components that are affected by the
exchange rate—a calculation of the tradable component of the CPI that takes into
account the fact that every product in the consumer basket is comprised of a tradable
component and a nontradable component. Assuming that over the long term, there is
full transmission of the tradable component of the CPI—at the level of precision
calculated here—we can assume that the tradable component’s percentage of the CPI
is an estimate of the overall transmission.
The study presents the intuition behind the approach and the manner in which the
various components are calculated through quantitative data on 159 industries, taken
from input-output tables that have been classified into CPI components by industry.
Through a method that has not been previously used, the study calculates with a high
level of precision the rate of imported products out of the Consumer Price Index (27.5
percent)—which are comprised of imported production inputs (10.9 percent) and
imported final products (16.6 percent)—and the rate of exportable products and
import alternatives by industry. The study makes it possible to estimate not only the
overall transmission over the long term, which, according to the results of this study,
is 36 percent, but also its channels—the components that create it—by industry and by
channel of effect.