Page 29 - Azerbaijan State University of Economics

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

where, , + is cumulative change in the price level while +1 is nominal effective
exchange rate between corresponding periods.

In order to examine the importance of exchange rate shocks, we also run variance
decompositions with the Cholesky ordering and determine the contribution of each
shock to CPI fluctuations.

Figures 4a-4d in Appendix A3 depict the impulse response functions of aggregate,
food, non-food and services CPI within twelve quarters. Solid lines are accumulated
impulse responses, while dotted lines represent one standard error confidence bands.
The accumulated response of aggregate CPI and non-food CPI is significant for 12
quarters, while response of food and services CPI stays significant only for three and
two quarters, respectively.

Table 2 contains the pass-through coefficients to aggregate CPI and its components.
The results show that exchange rate pass-through is incomplete in Azerbaijan. 40
percent change of NEER is passed to aggregate CPI by the 4th quarter. After a shock
to NEER, the ERPT to food CPI reaches 53 percent in the first year, while non-food
CPI changes by 35 percent within a year. However, in the long-run cumulative pass-
through to food and non-food CPI reaches 38 and 56 percent, respectively. The
services component is the least affected variable by the exchange rate shocks. The
highest pass-through occurs in the third quarter, where the coefficient is 19 percent.

Surprisingly, ERPT on food prices is highest among others. Since a large part of
food products is produced locally and sold in local currency, the consumers could
prefer to buy local food products due to a rise in imported food prices (IMF, 2016).
In other words, we would have expected that expenditure switching would cause the
degree of the ERPT to decline. However, in non-food sector consumers do not have
many options to choose from. According to Official Customs Statistics, food and
tobacco products account for less than 20 percent of imports in 2020, while non-
food products are about 70 percent of total imports. In other words, since non-food
importers have significant market power, the exchange rate shocks would be
transmitted into domestic prices to a great extent. However, the results suggest that
importers prefer to adjust their markups rather than transmit exchange rate changes
into prices. Low pass-through in services CPI could be attributed to regulated price
effects. Around 12 percent of services in the CPI basket are regulated by the
government. In fact, after the recent devaluations in 2015, authorities did not allow
administrative prices to increase in order to keep service inflation in check (IMF,
2016). Overall, the results suggest that the ERPT is heterogeneous across CPI
components in Azerbaijan.
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