Threshold Model of the Exchange Rate Pass-Through Effect

Abstract

This paper investigates the exchange rate pass-through (ERPT) effect in Croatia using a threshold model. To date, empirical studies have failed to find a high degree of ERPT in Croatia, even though exchange rate stability has been one of the goals of monetary policy throughout the transition period. Using a nonlinear model, this study demonstrates that ERPT is present in the data and shows why it cannot be detected with a linear model. According to our estimates, there is a threshold at 5.91 percent of the monthly growth rate of the nominal exchange rate of the German mark (euro), with the 95 percent interval between about 2.7 and 21.8 percent. Consistent with the theories of sticky prices or pricing to market, ERPT is asymmetric around the threshold: below it, the ERPT effect is weak or statistically insignificant, and above it, the effect is strong and significant.