Exchange Rate Pass-Through, Inflation, and Monetary Policy in Egypt

Abstract

The role of exchange rate pass-through has dominated the recent heated debates over effective monetary policies as well as exchange rate regimes in general equilibrium models. Empirical literature from developed economies has provided evidence that in many cases, the pass-through to prices may be incomplete. These studies report substantial differences between countries. To fill the gap in empirical literature on developing countries, in the present article, we examine exchange rate pass-through in Egypt from 2005 to 2018 using nine endogenous variable vector auto-regressive models (VAR), estimating the degree and the size of exchange rate pass-through to domestic prices. In addition, we use a reduced two-dimensional VAR to estimate once for the relation between inflation (CPI) and money supply (M2) and once for the relation between inflation (CPI) and imports, along with Granger causality tests to investigate causality between two variables. In the last part of the analysis, we investigate the exchange rate pass-through to inflation (CPI) in Egypt before floatation, from December 2005 to October 2016, and in the post-floatation period, from November 2016 to February 2018. The results have important implications for Egypt’s ability to achieve an effective inflation-targeting regime.