Time varying pass-through: Will the yen depreciation help Japan hit the inflation target?

• Unconventional monetary policies seem to lead to currency depreciation.
• But we used to think that pass-through to domestic prices was gone.
• This paper finds that pass-through has made a dramatic come-back lately.
• This is especially true for items that consumers purchase frequently.
• Raising those prices could also affect inflation expectations.

This paper argues that the exchange rate could be a powerful transmission channel of the effects of ongoing “unconventional” monetary policies in Japan. It is shown that exchange rate pass-through to domestic prices, once considered near-extinct, has come back strong in recent years. This is especially true for those items that households purchase frequently. Evidence based on VARs as well as TVP-VARs indicates that a 25% depreciation of the yen would produce a 2% increase in the prices of those items. This could have an additional benefit of raising the public’s expectation about future inflation, as their beliefs are often said to be influenced by their daily observations about prices of those items that they buy frequently.