Exchange Rate Pass-Through and Monetary Integration in the Euro Area

The purpose of this study is to examine how monetary integration affects the exchange rate pass-through, by testing whether monetary policy convergence in the euro area led to a convergence in terms of exchange rate pass-through. We conduct a comparative study between the “experiment group” (the euro area) and the “control group” (non-euro industrial countries).  We find evidence for stronger convergence of exchange rate pass-through for the euro area economies as a group, especially around the 1980s.  The group of non-euro industrial countries also had conditional convergence (convergence with permanent cross-sectional heterogeneity) in exchange rate pass-through, but its cross-sectional dispersion remains substantially larger compared to the euro area.  This indicates that monetary integration affects the exchange rate pass-through.  This has an important policy implication for the euro area, especially for the new member countries, as their exchange rate pass-through would not remain constant or purely exogenous; it should also converge to the euro area average as they work to achieve the Maastricht Criteria.

Keywords: Monetary Policy, Central Banks and Their Policies, International Monetary Arrangements and Institutions.

JEL Classification: E52, E58, F33.

Working paper no. 308