Exchange Rate Pass-through Under the Unconventional Monetary Policy Regime

Author Name YOSHIDA Yushi (Shiga University) / Weiyang ZHAI (Shiga University) / SASAKI Yuri (Meiji Gakuin University) / Siyu ZHANG (Meiji Gakuin University)
Creation Date/NO. March 2022 22-E-020
Research Project Exchange Rates and International Currency
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We apply the structural VAR model to Japan under the unconventional monetary policy regime, 2000Q1 and 2019Q4. In addition to the traditional sign restrictions, we impose narrative sign restrictions based on five phenomenal economic episodes. Estimated exchange rate pass-through induced by monetary policy shock or exogenous exchange rate shock is consistent with the conventional view, i.e., a Japanese yen depreciation induces inflation at the consumer level. On the other hand, we found evidence of perverse exchange rate pass-through induced by demand shock. A ten percent exchange rate depreciation driven by weak domestic demand is associated with a one percent deflation at the consumer level. The magnitude of the latter effect is greater than the former. This demand-shock-induced exchange rate pass-through effect may have undermined the continuous efforts of the Bank of Japan to achieve the target of a two percent inflation rate.