Much Ado about Something Important: How do Exchange Rate Movements Affect Inflation?

Understanding how exchange rate movements pass-through' to prices and inflation is critically important for monetary policy. Yet key tenets of our standard framework for analyzing this pass-through' have recently not performed well in the UK. Instead, a new framework is neededof incorporating the cause of the exchange rate movement when analyzing its effects. This new framework can explain why sterling's movements have had such different effects on import prices and inflation over time. It should also improve the ability of central banks to predict inflation and set monetary policy appropriately.