Non-linearities in exchange rate pass-through: Evidence from smooth transition models

This paper examines the presence of non-linear mechanism in the exchange rate pass-through (ERPT) to CPI inflation for 12 euro area (EA) countries. Using smooth transition regression (STR) model, we explore the existence of nonlinearities with respect to the inflation environment. We find strong evidence that pass-through respond non-linearly to inflation level for 8 out of 12 EA countries, that is, the transmission of exchange rate is higher when inflation rate surpass some threshold. Our results provide a broad support to the hypothesis suggested by Taylor (2000) that ERPT is decreasing in a lower and more stable inflation environment.