Page 19 - Azerbaijan State University of Economics

THE JOURNAL OF ECONOMIC SCIENCES: THEORY AND PRACTICE, V.78, # 2, 2021, pp. 17-42

As a result, the supply of domestic products becomes insufficient to satisfy all
demand and thus, it creates an upward pressure on the price of local products. At the
same time, due to the weakened currency, exported goods become more competitive
in international markets and demand for labor in export-oriented sectors goes up.
According to Lafleche, it may lead to possible wage rises and a surge in consumer
prices.

Due to the lack of the relevant literature and importance of the exchange rate shocks,
in this paper we will study the ERPT mechanism in Azerbaijan. We will examine the
degree of the ERPT to CPI and its components for the period of 2003Q1-2021Q2.
The empirical model is the VAR in first differences estimated following Cholesky
decomposition method.

The paper contributes to the literature mainly in two ways. Firstly, the ERPT to CPI
components has not been studied so far for Azerbaijan individually. To our
knowledge, this is the first study which presents the pass-through coefficients on
major CPI components namely food, non-food, and service CPI in Azerbaijan.
Secondly, this paper employs the post-floating regime period which is of great
importance due to increased exchange rate volatility and hence, for accurate
estimation of the ERPT.

The major finding of the paper is that the degree of the ERPT in Azerbaijan is
incomplete. According to our estimates, the accumulated pass-through of NEER
fluctuations on aggregate CPI rises from 18 percent in the first quarter to 40 percent
in the first year and reaches a maximum of 41 percent in the fifth quarter. The
accumulated pass-through coefficient on food CPI and non-food CPI equals 53
percent and 35 percent respectively, in the first year, while highest pass-through
th
th
occur in the 7 (56 percent) and 6 quarter (38 percent), respectively. For service
CPI, the pass-through is estimated to be 19 percent during the first year.

The rest of the paper proceeds in the following way. In the second section, we
provide some important facts on the peculiarities of the economy of Azerbaijan. The
third section lays out theoretical framework on the ERPT and surveys the existing
literature. In section 4, we describe the relevant data and develop the empirical
methodology. The fifth section presents the empirical results, and the last section
concludes.

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