Comparison study of methodologies for estimating the long-run exchange rate pass-through to import prices for South Africa

AbstractThe resilience of trade balances of the major industrialised economies such as the US andJapan to changes in their exchange rates following the switch from fixed to floating exchangerate regimes, triggered interest in the exchange rate pass-through relationship. Because of theimportance of the pass-through issue particularly in economic policy formulation, a sizeableliterature has developed over recent years. Comprehensive surveys of this literature includeMenon (1995), Goldberg and Knetter (1997) and McCarthy (2002). However, not muchattention has been paid to the comparison of the methodologies for estimating exchangerate pass-through. This research report aims to address this imbalance by comparing someof the exchange rate pass-through estimation methodologies via a Monte Carlo simulationstudy, based on the South African data set. The econometric results reported in this researchreport suggest that the Johansen type VECMs are superior to polynomial distributed lagmodels, exchange rate pass-through to South Africa’s import prices is incomplete (around78%) and that the speed of adjustment to long-run equilibrium is low, about 7 per cent ofdisequilibrium in the previous month is corrected in the current month. We conclude thatif we are not sure about the unit root properties of the data (as is normally the case), thenthe ARDL precedure is the appropriate model for empirical work.