An Analysis of the Exchange Rate Pass-through and the Inflation Dynamics in Iran: Regime Switching Approach

Exchange rate pass-through (ERPT) is the extent to which changes in the exchange rate affect import prices and, as a result, local prices. In the Iranian economy, being oil-dependent and having an unstable exchange rate market, an understanding of the degree of ERPT is of importance for the success of anti- inflationary policies. Taking the inflationary features of the economy of Iran into consideration and using the methods of regime transition, this study examines the exchange rate pass-through in the Iranian economy in the condition of dependency on inflation regime during 1990-2000. The results indicate that ERPT in the economy of Iran is dependent on the inflation regime and is meaningful only in high inflation regimes. In a system of managed floating, the mission of the central bank is to control the exchange rate. Also, in such conditions, significance market management can help to prevent any undesirable impulsive effect of foreign currencies on the local inflation.