Introduction:
Exchange rate is the one of the principle elements deciding crude material costs, middle of the road products, capital hardware and peripheral merchandise. Because of the high reliance of creation and utilization on imports, it appears it influences the arrangement of inflationary weights.
As a result of the significant change in the conversion scale administrations, the trade rate variable has ended up being a key component of impact on financial approach, and the effect of its vacillations on expansion and local costs has turned into a typical monetary issue (Delatte and Villavicencio, 2012).
Exchange rate pass-through is the magnitude to which exchange rate changes are reflected in the destination currency ( local prices ) of traded goods (Pollard & Coughlin, 2006). There exists a large literature that studies the phenomenon of exchange rate pass- through, they found that ERPT has been diminishing since the last decades(Pérez, Fernando & Vega, Marco, 2015).
Emerging economies like Jordan, their central banks must answer to a question like does the change in domestic inflation react conversely to changes in the exchange rate , The answer depends on the conduct of monetary policy, especially the level and speed with which monetary authorities try to set the inflation and exchange rates. The Central Bank usually fine-tunes the prime rate to respond to the exchange rate movements. However, the use of monetary policy rate as a reaction to exchange rate must be prevail with much thoughtful considerations, (Maka, E 2013).
1- The problem of the study:
The importance of monetary stability origins from being one of the main pillars upon which countries can move the economic activity and create favorable environment for domestic and overseas investments, therefore the monetary authorities seek to achieve this goal by maintaining the stability of the local currency exchange rate, but in the continuous budget deficit and structural imbalances in the balance of payments, so we can’t accomplish the above objectives, and take crucial decisions in reducing the impact of transmission of exchange rates to the price indices.
The problem of the study can be formulated through the following question:
What are the determinants of transmission of the impact of the foreign exchange rates on price indices in Jordan ?
2- The Study Objectives:
1- Determine the factors affecting the transmission of the impact of foreign currency exchange rates to goods and services prices in the Jordanian economy, and the importance of these factors and the degree of the impact by identifying the size and speed of transmission of the impact of exchange rates to price index.
2- Recognize the moves of foreign currencies exchange rate prices that affect price index in Jordan?
3- Recognize change in the money supply that affect exchange rate of foreign currencies pass-through on price index in Jordan.
4- Recognize change in oil prices that affect exchange rate of foreign currencies pass-through on price index in Jordan.
3- The questions of the study :
1- Do the moves of foreign currencies exchange rate prices affect price index in Jordan?
2- Will the change in the money supply affect exchange rate of foreign currencies pass-through on price index in Jordan?
3- Will the change in oil prices affect exchange rate of foreign currencies pass-through on price index in Jordan?
4- The importance of the study:
The importance of the study can be summarized through identifying the factors affecting the transmission of the impact of foreign currency exchange rates to goods and services prices in the Jordanian economy to assess the monetary policy and to dilutes the effects of inflation on exchange rates.
5- The study Hypotheses:
The basic hypothesis: Moves of foreign currencies exchange rate prices affect price index in Jordan .
First-sub-hypothesis: change in the money supply affect exchange rate of foreign currencies pass-through on price index in Jordan.
Second-sub-hypothesis: change in oil prices affect exchange rate of foreign currencies pass-through on price index in Jordan.
Methodology
1- Data of the study : The study used data series analysis (annually) dependent and independent variables in the years (1996-2005), and the data analyzed using E-VIEWS.
2- Statistical method: single regression equation.
Literature review
Analyzing Mechanism of Exchange Rate Pass – Through:
The beginning stage in the examination of transmission (reflection) of trade rates to be considered (The Law of One Price), which stipulates that the cost of the ware exchanged and comparative between the two states is the same in both residential and remote economy, when communicated in a typical coin.
And it expresses the law of one price through the following equation:
P = P ………………… (1) * e
P: domestic price of a commodity traded (imported) which are expressed in local currency.
P*: Price of the commodity in the foreign economy (exporting) expressed in any foreign currency.
e: Exchange rate expressed as the number of units of local currency needed to buy one unit of Foreign currency (so increase in (e) denotes a decline of the local currency value).
• For the law of one price when the foreign price change, and deviation happens for commodities will change but by a different change in exchange rates, and here is a reflection of the impact of exchange rates is incomplete.
The theory of purchasing power parity absolute:
This theory states that the price of a commodity in a country be equal to the price in another country taking into account the conversion value of the currency in the second country:
Through this theory determine a currency by dividing the price of the commodity currency exchange Item price on the local foreign currency and through the following equation:
e = P / P *
The theory has been met PPP absolute many criticisms in the practical side, as some economists believe that there is the difficulty of the abolition of the costs of access to information and the costs of the movement of goods between the markets in the framework of the process of arbitrage.
The theory of purchasing power parity relative:
Applied as a result of defects in the absolute purchasing power parity theory, a theory emerged PPP relative to less stringent appearance in conditions where only just assuming equal to inflation differential between domestic and foreign commodity markets and change the exchange rate as a condition for balance
For this theory through the following equation:
% ∆e = % ∆P – % ∆ P*
% ∆e : The amount of the relative change in the exchange rate.
% ∆P :The relative change in domestic inflation.
% ∆ P*: The relative change in the foreign inflation.
• Factors Explaining Exchange Rate Pass – Through:
• Supply – Demand Elasticity:
• Demand Elasticity:
Price elasticity can be generally defined as the percentage change in quantity on the percentage change in the price.
ED = % change in quantity demanded / % change in Price
• Supply Elasticity:
• Definition of price elasticity of supply as the percentage change in quantity before the percentage change in the price.
∆s = % ∆ Qs / % ∆ P
∆s : Price elasticity of supply plants
∆ Qs: Change in the quantity supplied
∆ P : change in price.
• Macroeconomic Variables affect exchange rate pass-through :
That macroeconomic shocks may work or booster of the impact of supply elasticity And demand, for example, when domestic demand is active, the reflection of the effects of exchange rates Imports is high regardless of the elasticity of demand and supply, when the contrast Domestic demand is weak or that the absorptive capacity is low, the margins of exporters Foreigners may be reduced and the reflection is incomplete and this may occur regardless of elasticity Supply and demand and affect other combination of the following macro-economic factors on the transition effects They exchange rates:
1- Inflation Level:Whenever the high levels of inflation in the country of export of goods increased the reflection effect of exchange rates.
2- Exchange Rate Fluctuations: Although the studies did not demonstrate the effects of these vibrations and whether negative or positive impact, but they agreed that there was a relationship between these vibrations between reflection and exchange rates
3- Size of Imported goods:The share of imported goods in the consumption basket is high and it was a reflection of the exchange rate is high, that is, the greater the economic openness of the state was the transition effects of exchange rates greater coefficient.
4- Imports combination: That the degree of transmission of the impact of exchange rates affected the categories of imported goods and not just the size of the quota.
5- Binding quantity constraints: When the foreign company is facing obstacles to the amount of influence the company's ability to increase its sales, In the importing country.
6- Size of Economics: Inflationary effects in the large states that occur as a result of depreciation of the local currency value In these countries on domestic prices is neutralized due to lower global demand from the state that it decreased the value of its currency, leading to a decline in the world price.
• Microeconomic Variables affect exchange rate pass-through : Micro-economic environment affecting factors on the level of individual industries on strategies The price situation, when trade in goods are heterogeneous in the integrated global market operations Remove arbitrage differences in the common currency for goods price.
1- Market share objectives:If the company's strategy focused on increasing market share even at the expense of what Profit margin, the high value of the currency of the importing country will pay the issuing company to reduce Prices of their goods to increase its market share in that country, and will lead to an increase in sales of goods, Then there will be a reflection of exchange rates on prices of domestic goods.
2- Production Switching: The exporting companies to choose between buying production inputs and raw materials From the local market or have imported, and swap between them is dependent on the price of those Input in the domestic and foreign market.
3- Menu Cost: The reversal of exchange rates explains in some respects given to the list of costs and the way The bill followed the pricing and assuming that the list of costs are similar to fixed costs, a change in price The bill be feasible if the exchange rate changes is higher than a certain limit. For example, If the price of the bill placed in the currency of the exporting country and the changes in exchange rates Currency simple importing country, it is not feasible to change prices by source Changes Statistics, which do not affect the price of exports and foreign currency leads to influence prices Imports in local currency in the same amount of change in exchange rates and a high reflectance, But if the changes in the currency high exchange rates of the importing country, it would be of Worthwhile to change the source Price own currency, and the work, the source absorbs part of the changes Price in the currency of the importing country and thus reduce the transmission of the effects of exchange rates .
Past studies:
1- Exchange rate pass-through and inflation targeting in Peru (2014): This study showed evidence of a similar decline in the pass-through in Peru, a small open economy that progressively reduced inflation to international levels in order to adopt a fully-fledged inflation targeting scheme in 2002.This study used a structural VAR framework to analyze the data. The study data such as inflation, inflation targeting, inflation expectations, and nominal currency exchange rate extracted from the central reserve bank of Peru from 1994 to 2010. The study concluded that the importance of pass-through effect for policy design in open economic points out that a low pass-through grants the central bank degrees of freedom to apply an independent monetary policy, and eases the implementation of an inflation targeting regime.
2- Exchange rate pass-through in Tunisia (2014): The objective of the study is to assess the degree of exchange rate transmission to consumer prices in Tunisia. The study used a time varying parameter to analyze the data. The estimation were conducted on quarterly data for the Tunisian economy for the period 1994-2010. The results showed an upward pass-through trend since the early 2000s. It increased from an average of 15% before 2001 to 25% currently. It reaches 30% in periods of depreciation. In the long term, nearly 60% of the depreciation of the exchange rate is transmitted to overall inflation and 28% to inflation excluding food and energy.
3- Exchange rate pass-through into import prices in Jordan (2013): The objective of the study is to investigate the exchange rate pass-through into import prices on aggregate and disaggregate data levels in Jordan. The study used the bounds testing method to cointegration and error correction model in a sample of annual data from 1976-2011. The results of the study showed that nominal exchange rate fluctuations and oil prices are the core determinants of import prices either on aggregate or disaggregate data levels, also it showed that in the short-run oil prices have longer impact on Jordan’s import prices compared to nominal exchange rate.
Data Analysis Techniques:
Data of the study : The study used data (annually) dependent and independent variables in the years (1996-2005), and the date analyzed using E-VIEWS