DP2001/06. How much do import price shocks matter for consumer prices? Tim Hampton. November JEL classification: C22, E31

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1 DP00/06 How uh do ior rie shoks aer for onsuer ries? Ti Haon Noveber 00 JEL lassifiaion: C, E3 Disussion Paer Series

2 DP00/06 How uh do ior rie shoks aer for onsuer ries? Absra New Zealand and Ausralia have reenly had large ior rie inreases on he bak of urreny dereiaions. Desie hese large ior rie shoks, onsuer ries have no risen as srongly as would be suggesed by reviously aeed relaionshis. The reen rolonged eriod of general US dollar srengh has also raised he rofile of exhange rae and ior rie ass-hrough in a nuber of oher ounries. We re-esiae shor- and long-run ior rie ass-hrough oeffiiens for New Zealand onsuer ries. The daa onfirs ha he esiaed oeffiiens are saller han reviously hough: a 0 er en inrease in ior ries will lead o a 0.5 er en inrease in onsuer ries wihin he firs quarer, and o a.5 er en inrease over he long-run. This resul suggess ha we should no neessarily exe he reen exhange rae dereiaion o resul in furher onsuer rie inreases. Siilarly, if he exhange rae were o areiae in he fuure, we should no exe large dereases in onsuer ries as a dire resul of he exhange rae areiaion. Inroduion The degree and iing of ass-hrough is ioran for foreasing inflaion and for seing oneary oliy in resonse o inflaion shoks. The er long-run ass-hrough yially refers o he oal hange in onsuion ries generaed by a ersisen or eranen ior rie shok, one onsuer ries have soed adjusing o he iniial ior rie shok. I has been suggesed ha he deline in he Ausralasian urrenies over 999 and 000 ay reresen a eranen or sruural down-shif, raher han jus a ylial henoenon. If his is he ase, and he exhange rae never reovers o revious ylial highs, hen undersanding long-run ass-hrough beoes very relevan. Irreseive of he long-run relaionshi, i akes ie for doesi onsuer ries o adjus o any new equilibriu, and undersanding he shor-run ass-hrough dynais is ioran for wo reasons. Firs, he shor-run dynais exlain he adjusen roess o ahieving he long-run ass-hrough for a given eranen shok o ior ries. Seond, undersanding he shor-run ass-hrough dynais hels o ie down he ia of eorary ior rie shoks on onsuer ries. The rie of iors over he doks inreased by around 5 er en in New Zealand and by er en in Ausralia in he wo years o he end of 000. The ior rie inreases were driven redoinanly by he large dereiaion in he Ausralasian exhange raes over ha eriod wih ior ries broadly ahing he exhange rae oveens one-for-one wihin one quarer. Over he sae eriod, onsuer ries in New Zealand inreased by jus 5 er en. This inrease in onsuer ries was no as large or as quik as reviously-aeed relaionshis would have suggesed (RBNZ (00)). I would like o hank John MDero and Chrisie Sih for heir assisane and oens on earlier drafs. The views exressed here are hose of he auhor and do no neessarily refle offiial osiions of he Reserve Bank of New Zealand. Any reaining errors and oissions are he resonsibiliy of he auhor. Conens ay be used wihou resriion rovided due aknowledgeen is ade of he soure. Eail: haon@rbnz.gov.nz. Reserve Bank of New Zealand. The reen eriod of rolonged general US dollar srengh has inreased he rofile of exhange rae and ior rie ass-hrough in a nuber of ounries ouside of Ausralia and New Zealand. The objeive of his researh is o idenify he long-run relaionshi beween ior ries and onsuer ries, and o idenify he shor-

3 run dynais involved. The heory behind ior rie asshrough and a suary of soe of he earlier eirial lieraure is disussed in seion. Seion 3 resens he eirial odels used in his aer, along wih he resuls. Seion 4 onludes. Theory and eirial lieraure A yial saring oin for idenifying he heoreial long-run ia of ior ries on onsuer ries is o assue ha he onsuion rie elasiiy wih rese o ior ries (he asshrough oeffiien) is equal o he equilibriu roorion of onsuion goods ha are iored. In he ase of New Zealand, iors aoun for aroxiaely 33 er en of onsuion goods. Therefore, based on he above assuion, a 0 er en inrease in ior ries would lead o a 3.3 er en inrease in onsuer ries in he long-run. This is an aroriae aroxiaion rovided ha i is only he ries of iored onsuion goods ha are affeed by he ior rie shok, and no he ries of doesially rodued onsuion goods. If oher ries are affeed by he ior rie shok hen here are a leas wo oenially offseing reasons why he ass-hrough oeffiien ay no be equal o he ior share of onsuion. Firs, a oveen in ior ries ay lead o a hange in onsuer ries ha is larger han ha suggesed by he ior share of onsuion. For exale, a osiive shok o oil ries, and herefore erol ries, ay lead o higher wage lais if soe wages are indexed o onsuer ries, whih in urn ay feed bak ino higher doesi inflaion. This henoenon, whereby higher ior ries lead o higher ries for doesially rodued goods is usually labelled indire or seond round ass-hrough. If seond round ass-hrough ours, hen he oal ass-hrough fro ior rie hanges o onsuion ries ould be greaer han he ior share of onsuion. Seond round ass-hrough is ore likely o These exales an be siilarly alied o delines in ior ries. However, he exales rovided in his aer are yially illusraions of he onsequenes of an inrease in ior ries. 3 lay a signifian role when he enral bank is oo slow o resond o ior rie shoks o reven inflaion ersisene. Conversely, he hange in onsuer ries generaed by he ior rie shok ay be saller han ha suggesed by he ior share of onsuion. I is ossible ha he ior rie shok ay resul in a relaive rie hange and no neessarily a levels shif in he overall onsuer rie index. For exale, if he ior rie inrease ourred wihou a oensaing hange in noinal inoe (via higher exor ries), he higher rie of iors ay sily be offse by lower ries for oher goods as deand delines a relaive rie shif. Beause of hese relaive rie shifs, he effe of an ior rie shok on onsuer ries ay be saller han he sile ior share of onsuion relaionshi suggess. This inoe effe is likely o be ore revalen in an eonoy wih a redible inflaion arge. For exale, if he rie of he noniored goods did no deline o oensae for he rising ior ries, he enral bank would be exeed o ighen oneary oliy in resonse o a osiive ior rie shok. Also, if he higher rie of iored goods resuls in dereased onsuion of iored onsuion goods, hen he iored share of onsuion igh also deline. Hene, he inrease in he oal onsuer ries fro he iniial ior rie shok ay again be saller han he original ior share of onsuion, beause of his subsiuion effe away fro iored onsuion goods. This subsiuion effe should be oounded by he oeing seors exansion. The offseing fores oulined above ean ha idenifying he exa agniude of he ass-hrough oeffiien is an eirial quesion. Dwyer and La (994) show ha he sizeable doesi oss involved in he disribuion and sale of iors ily ha he longrun ior rie ass-hrough oeffiien in Ausralia will be lower han he share of onsuion goods ha is iored. However, in a ore reen sudy, Gruen and Leong (00) find ha he esiaed long-run ass-hrough fro ior ries o doesi onsuion ries in Ausralia is beween 0. and 0.4. This is oarable o he ior share of onsuion in Ausralia, whih is around 30 er

4 4 en. Hene Gruen and Leong (00) ould no onlude whih of he above effes doinaes. Consuer ries do no adjus o heir new long-run value insananeously following an ior rie shok hese hings ake ie. Firs will usually aler heir argins and absorb soe of he ior rie shok a leas eorarily unil hey ge a beer undersanding of he naure of he ior rie shok or unil arke ondiions hange. This arial ass-hrough refles he fas ha i is yially osly for firs o adjus ries (due o enu oss) and ha hey are generally unsure wheher ior rie oveens are going o be eranen or jus ylial. Firs herefore delay soe, or all, of heir rie adjusen unil hey deerine he duraion of he shok hus varying heir argins hrough he yle. A desire o ainain arke share will also enourage firs o delay inreasing heir rie in resonse o higher ior ries unil heir oeiors have oied o a siilar rie rise, again varying heir argins. Debelle and Wilkinson (000) lo he esiaed shor-run asshrough oeffiien fro a ie series of 0 year rolling regressions of a differene equaion for he eriod 983Q o 000Q. They show ha he oeffiien for New Zealand has delined fro around 0.05 (a 0 er en rise in ior ries would lead o a 0.5 er en rise in onsuion ries wihin one quarer) for he 0 years o 99, o around 0.0 for he 0 years o 000. Afer allowing for feedbak fro as inflaion o urren inflaion, Debelle and Wilkinson s full-sale esiaes ily ha a 0 er en oveen in New Zealand ior ries leads o a.5 er en oveen in doesi onsuer inflaion wihin onhs, and a.3 er en oveen afer wo years. This oares o heir esiaes for Ausralia of 0.6 and.0 er en reseively, 0. and 0.3 er en for Canada, and 0.8 and 0.9 er en for he Unied Kingdo. Using a veor auoregression aroah, MCarhy (000) esiaed he oeffiiens for a nuber of ounries, and found a uh larger value for he Unied Kingdo around 5 er en. 3 This suggess ha he esiaes of ior rie ass-hrough 3 MCarhy (000) esiaed he elasiiy fro he exhange rae o onsuer ries raher han fro ior ries o onsuer ries. However, even allowing for his differene, heir esiaes sill sugges uh larger ior rie ass-hrough han do hose of Debelle and Wilkinson (000). 5 ay be sensiive o he esiaion ehnique used. Debelle and Wilkinson s resuls sugges ha he exen of shor-run ior rie ass-hrough has delined in os ounries sine he beginning of he 980s. However, hey do no onlude wheher his deline in shor-run ass-hrough is a resul of a reduion in long-run asshrough, or wheher he ass-hrough has jus beoe ore roraed. Taylor (000) us forh he view ha he reored deline in asshrough or riing ower around he world is due o he low inflaion environen ha has been ahieved in any ounries. Firs, a iroeonoi odel of rie seing is used o show ha lower ass-hrough is aused by lower ereived ersisene of os hanges. Evidene is hen resened showing ha inflaion is osiively orrelaed wih inflaion ersisene, suggesing ha he low inflaion iself has aused he low ass-hrough. Dwyer and Leong (00) suor he view ha rie sabiliy has had a signifian ia on reduing seond round ass-hrough in Ausralia in he sense ha inflaion exeaions are beer anhored so uni labour oss are less affeed by exhange rae shifs. However, hey noe ha firs round ass-hrough has also fallen sine he adven of rie sabiliy. Finally, ior rie ass-hrough in Ausralia aears o be asyeri: he ass-hrough of landed ior ries is slower during areiaions han during dereiaions (Dwyer, Ken and Pease (993)). In he even of dereiaion i akes wo years before half of he esiaed ass-hrough is realised. In he even of areiaion, i akes even longer. 3 Eirial odels and resuls The heoreial basis for his aer is a ark-u fraework, whereby onsuer ries are reresened as a ark-u over he oss of roduion. Assuing ha he eonoy an be divided ino raded and non-raded seors, and ha exorables are no onsued, he relevan oss are uni labour oss in he non-raded seor and

5 6 ior ries. 4 In he long-run, herefore, we should have (u o a onsan): ul ( ) ' () NT where is logged onsuer ries, ul NT is logged uni labour oss in he non-raded seor, is logged ior ries lus ariffs, and is he non-raded roorion of he eonoy. No offiial ie series exiss for New Zealand uni labour oss for he non-raded seor only, and hene equaion () anno be esiaed direly. We herefore ake he following daa ransforaion o orre for his. 5 We ake he oon assuion ha he rend rae of labour roduiviy growh in he raded seor is higher han in he eonoy as a whole. As a onsequene, uni labour oss rise ore slowly in he raded seor han in he eonoy as a whole, ul ul x () T * where ul is logged eonoy-wide uni labour oss, ul T is uni labour oss in he raded seor, is a linear ie rend, and x is he assued differene beween raded and eonoy-wide raes of labour roduiviy growh. Treaing aggregae uni labour oss as a geoeri average of uni labour oss in he raded and non-raded seors yields: ul ul ( ) ul (3) NT T and onsequenly, equaions () and (3) an be obined o show ha ul ul ( ) x (4) NT * whih ay be subsiued ino equaion () o give or where 7 ul ( )( ' x * ) (5) ul ( ) (6) ' x * To alulae he value of x, he differene beween raded and eonoy-wide raes of labour roduiviy growh, we required esiaes of labour roduiviy growh for eah of he seors over he sale eriod. The radable seor was haraerised as enoassing agriulure, huning, foresry, fishing, anufauring, ining, and quarrying. The level of roduiviy for eah seor was alulaed as he seasonally adjused level of eloyen in he seor (as easured by he Household Labour Fore Survey) divided by seasonally adjused real GDP for ha seor. x was alulaed as he average differene in he quarerly growh raes of eonoy wide and raded seor labour roduiviy for he eriod 989Q o 00Q. As noed in seion, here are a nuber of reasons why he esiaed value of ay no equal he non-raded roorion of he eonoy even in he long-run. We herefore esiae he following unresried equaion: ul GAP GAP (7) 3 i i0 4 5 Uni labour oss an also be hough of as a roxy for rie exeaions and noniored arginal oss. This seion is drawn exensively fro Beehey e al. (000). whih is very siilar o he odel develoed in de Brouwer and Erisson (995). Failure o ake he above adjusen o he ior rie series would ean ha he esiaed value of would oversae is rue value. The added inlusion of he ouu ga (GAP) and an aeleraor er on he ouu ga in equaion (7) is

6 8 onsisen wih he resul ha ouu gas are useful in exlaining onsuer rie inflaion (Coe and MDero (997)). A few oher oenial robles wih esiaing ior rie asshrough using a ark-u equaion are worh noing a his oin. The firs is ha onsuer ries are no jus a ark-u over roduion oss, bu hey also inlude indire axes. Seond, firs ark-us ay vary over he long-run biasing he long-run oeffiien esiaes. A he end of seion 3. we ake an allowane for his oenial bias, and find ha i does no have a signifian effe on he resuls. Third, here are oenial robles wih assuing an eonoy-wide ark-u, raher han rying o allow for differen ark-us a a ore disaggregaed level. Finally, ark-u equaions are only redued fors of he behaviour of ries in he eonoy. In ariular, he oneary auhoriy and inflaion exeaions aear only iliily under his seifiaion. 9 Taking hese resuls in onjunion wih reviously held heoreial ereions of he daa roeries, i was deided o rea onsuer ries, ior ries, and uni labour oss as I() series, and he ouu ga as a saionary series. 3. Coinegraion levels odel This subseion uses eonoeri analysis o ry o idenify he longrun ior rie ass-hrough oeffiien. Assuing ha ior ries, onsuer ries, and uni labour oss are all I(), i is aroriae o esiae he long-run relaionshi reresened by equaion (7) using oinegraion analysis. Sok and Wason (993) show ha he oinegraing veor an be esiaed by a sile ordinary-leas-squares (OLS) regression augened by lead and lag differenes. Equaion (7) hen beoes: 8 Wih hese oins noed, we roeed o use varians of he above ark-u odel o esiae he ass-hrough oeffiien for New Zealand ior ries. Firs we es for uni roos in he series, before roeeding o esiae he long-run relaionshis. s s s ul GAP s ul s s 3 i0 GAP i (8) 3. Uni roo ess Table shows he resuls of Augened Dikey-Fuller uni roo ess on,, ul, and GAP for he eriod 989Q o 00Q. 6 The resuls sugges ha ior ries and uni labour oss are inegraed of order (I()), while hey reje he null hyohesis ha he ouu ga is non-saionary. Alhough he es rejes he null hyohesis of a uni roo in onsuer ries, a lo of he series and he orrelogra suggess ha he series exhibis a uni roo This eriod was hosen beause ior rie daa inluding ariffs was no available rior o his dae see he Daa Aendix for deails of he ariff ie series. The odel was also esiaed for he eriod 99Q o 00Q he eriod sine inflaion was sabilised in New Zealand bu his did no have a signifian effe on any of he resuls. The null hyohesis of eah of he series being I() was rejeed for all of he series. The resuls are no reored here. Sok and Wason (993) exlain ha he advanage of esiaing equaion (8), as oosed o equaion (7), is ha he inlusion of he firs differene variables hels orre for oenial endogeneiy fro onsuer ries bak ino uni labour oss and ior ries. This dynai OLS esiaor erfors well, in a sall sale sense, relaive o oher asyoially effiien esiaors. Sok and Wason (993) do no exliily exaine he ase where exogenous saionary inus are inluded, in his ase he ouu ga ers, bu suh inus an be aoodaed (see Phillis (99)). Hailon (994, 608-6) shows ha an OLS regression of equaion (8) will rodue inorre sandard errors, and suarises he ehodology for esiaing a onsisen esiae of he sandard error of he regression. This onsisen esiae is denoed as. 8 Addiional lags and leads were inluded in he original regression, bu were droed due o heir lak of saisial signifiane. The esiaes for and were no affeed by he inlusion of he addiional lags.

7 0 This aroah an be alied o a regression ha is esiaed using any asyoially effiien esiaor. Equaion (8) saisfies his ondiion. Hailon (994, 608-6) shows ha he sandard OLS F saisis an be ransfored ino orre es saisis by ulilying he by he raio (s / ), where s is he unadjused OLS sandard error of he regression. Siilarly, he OLS sandard errors an be ransfored ino onsisen sandard errors by dividing he by he raio (s / ) /. If he dynais of (fro equaion (8) above) were o be aroxiaed on he basis of q auoovarianes, he Newey-Wes esiaor an be used o obain a onsisen esiae of : where q [ j /( q )] (9) j T o j j T j j and are he residuals fro equaion (8) above. 9 A desirable roery of ark-u equaions is sai hoogeneiy. Sai hoogeneiy saes ha an equal erenage hange in uni labour oss and ior ries will ause a one-for-one erenage hange in onsuer ries in he long-run. Sai hoogeneiy herefore ensures ha oneary oliy anno resul in long-run relaive rie hanges (eg beween onsuer goods and ior ries). The resriion of sai hoogeneiy revens oneary oliy fro having a long-run oosiional effe on he real eonoy via relaive ries. In equaion (8), sai hoogeneiy is iosed by seing + =. A Wald es on his resriion was ondued, he resuls of whih are resened in able. The resriion was aeed by he daa, and hene he reainder of he resuls are for equaion (8) wih sai hoogeneiy iosed. If he ior rie series was no adjused for he ross-seoral roduiviy differenes, as desribed a he beginning of seion 3, sai hoogeneiy was rejeed. Engle-Granger oinegraion ess were also erfored o es wheher a long-run relaionshi exiss beween he level of onsuer ries, ior ries, and uni labour oss (in he long-run, he ouu ga is assued o have a ean of zero). Hyohesis es resuls, he oeffiien esiaes, and he adjused sandard errors fro equaion (8) wih sai hoogeneiy iosed are all resened in able. The oeffiien resuls for he dynai variables are no inluded in he able beause hey were only inluded in he regression o solve for oenial endogeneiy robles. However, he oeffiien esiaes on he ouu ga variables are inluded in he able beause hey are oenially of eonoi ineres. The resuls sugges ha he ior rie ass-hrough oeffiien is 0.4. This ilies ha if ior ries inrease by 0 er en, hen onsuer ries will inrease by around.4 er en in he longrun. 0 This is around half of he value of he ior share of onsuion for New Zealand, suggesing ha here is yially a lo of relaive rie shifs following an ior rie shok, and relaively lile seond round ass-hrough. This is onsisen wih he Reserve Bank of New Zealand oeraing wihin a redible inflaion-argeing environen. The Engle-Granger es on he residuals fro equaion (8) rejeed he null hyohesis of no oinegraion, herefore suggesing ha a long-run relaionshi does exis beween ior ries, onsuer ries, and uni labour oss. This finding validaes he above oeffiien esiaes. If firs rofi argins hanged signifianly over he esiaion eriod, hen exluding soe easure of rofi argins fro he above analysis ould bias he resuls. Hene equaion (8) was reesiaed wih a easure of argins (alulaed fro he naional aouns) in levels. The oeffiien on he argins variable was negaive a resul ha was inonsisen wih he idea ha firs 9 The value of q was se equal o he nuber of saisially signifian auoorrelaion oeffiiens fro he residuals obained fro equaion (8). 0 This ehodology assues ha he ia of ior rie oveens on onsuer ries is syeri.

8 rofi argins and heir selling rie are osiively orrelaed. Neverheless, is inlusion in equaion (8) did no have a signifian ia on he oher oeffiiens. Therefore, he argins variable was exluded fro he analysis. 3.3 Error-orreion ehanis The nex objeive was o deerine he shor-run adjusen roess required o ahieve he long-run relaionshi. Having idenified a sable oinegraing relaionshi, i is onvenien o re-esiae he above relaionshi using an error-orreion ehanis (ECM): ( GAP i0 ul ) i s s s s s GAP ul s 3 (0) Re-esiaing he above relaionshi using an alernaive seifiaion, suh as an ECM, also hels o es he robusness of he earlier resuls. As in equaion (8), he resriion of sai hoogeneiy + =, was esed. The resuls of his es are resened in able 3, and again he resriion was aeed. As a resul, he reainder of he resuls are fro equaion (0) wih he resriion of sai hoogeneiy iosed. The regression resuls are shown in able 3. The esiaed oeffiien on he error-orreion er,, is around -0.37, ilying ha around 37 er en of a disequilibriu in he long-run relaionshi is orreed eah quarer. This oeffiien is saisially signifian, suoring he earlier resul ha a long-run relaionshi exiss beween ior ries, onsuer ries, and uni labour oss. The oeffiien an be used o aroxiae how long i would ake for half of any deviaion fro he long-run equilibriu o be eliinaed. This half-life is alulaed using: 3 The oeffiien obained fro equaion (0) is equivalen o saying ha he half-life is around 5 onhs. The and fro he ECM are very siilar o hose obained fro equaion (8), and sugges ha he ior rie ass-hrough oeffiien is 0.6 (0.4 in equaion (8)). Cobining he and oeffiiens fro he ECM, and ignoring he i oeffiiens, a 0 er en inrease in ior ries would lead o a 0.6 er en inrease in onsuer ries wihin one quarer. 3 The long-run ior rie ass-hrough oeffiiens esiaed here are a lile lower han hose alulaed by Debelle and Wilkinson (000), while he seed of adjusen is quiker. One ossible exlanaion for he differenes ses fro he fa ha Debelle and Wilkinson (000) use headline ior ries, while his aer uses ior ries adjused for ariffs and he differene in labour roduiviy growh beween he raded and non-raded seors. Seond, he analysis done by Debelle and Wilkinson (000) uses a sile differene equaion, whereas his aer uses oinegraion based esiaion ehniques. 4 Conlusion The objeive of his aer was o deerine he relaionshi beween ior ries and onsuer ries in New Zealand. Undersanding boh he long-run ia and he shor-run dynais of ior rie shoks on onsuer ries is ruial for oneary auhoriies in sall oen eonoies. Furher, he reen eriod of rolonged US dollar srengh has raised he rofile of exhange rae and ior rie ass-hrough in a nuber of oher eonoies besides New Zealand. halflife ln( 0.5) / ln( ) () Addiional lags and leads were inluded in he original regression, bu were droed due o heir lak of saisial signifiane. The esiaes for and were no affeed by he inlusion of he addiional lags. 3 This aroxiaion of he half-life does no ake ino aoun he dynai adjusen ers reresened by he i oeffiiens. However, given ha hese oeffiiens are saisially and eonoially sall in his exale, he above equaion gives a lose aroxiaion. Again, his esiaion does no ake ino aoun he i oeffiiens.

9 4 The resuls sugges ha he long-run ior rie ass-hrough oeffiien for New Zealand is around 0.5, wih around half of any deviaion fro he long-run relaionshi being orreed in around five onhs. Cobining hese wo resuls suggess ha a 0 er en inrease in ior ries will lead o a 0.5 er en inrease in onsuer ries wihin he firs quarer, and o a.5 er en inrease over he long-run. Earlier inernal researh done a he Reserve Bank of New Zealand (using daa for he eriod 985 o he id 990s) suggesed ha he long-run ior rie ass-hrough oeffiien was around 0.5 o The uh lower value of 0.5 esiaed in his aer is onsisen wih he ore reen inforal analysis of he Reserve Bank, whih suggess ha he reen dereiaion in he exhange rae has no resuled in inreases in onsuer ries as large as we had exeed (RBNZ (00)). Table : Uni roo ess Tes saisis (5 er en riial values) d -4.75* (-3.50).0 (-.95) ul -.5 (-.93) GAP -.08* (-.95) 5 Lags Consan Trend 0 Yes Yes 0 No No 0 Yes No 0 No No This resul suggess ha here ay no neessarily be furher large inreases in onsuer ries arising fro he reen exhange rae dereiaion. Conversely, any fuure exhange rae areiaion should no be exeed o have a large dire ia on onsuer ries. An ioran avea o his analysis is ha he easured value of he long-run ior rie ass-hrough oeffiien also akes ino aoun any ia of hanges in oneary oliy following a shok o ior ries. The fa ha he ass-hrough oeffiien is signifianly lower han he ior share of onsuion is onsisen wih he Reserve Bank oeraing a redible inflaion argeing regie. The inflaion argeing regie has heled o ensure ha an inrease in ior ries is yially e wih relaive rie shifs in onsuer goods, wih soe doesially rodued goods ries falling o offse he rising rie of iored onsuer goods, and liied, if any, seond round or indire ass-hrough. I herefore follows ha in a differen regie, where he Reserve Bank was no exeed o ighen oliy in resonse o ior rie shoks ha hreaened o desabilise inflaion exeaions, hen he asshrough oeffiien would robably be higher han he 0.5 esiaed here. Noes: * indiaes signifiane a he 5 er en level of signifiane. The null hyohesis of a uni roo was esed using he Augened Dikey-Fuller uni roo es. Saring wih eigh lags, and sequenially droing he saisially insignifian ones deerined he lag lengh. The onsan and rend variables were exluded if hey were no saisially signifian. The riial values were obained fro Hailon (994).

10 6 Table : Coeffiien esiaes and hyohesis ess for equaion (8) Coeffiien esiaes (sandard errors) Ior ries 0.4 (0.0) Uni labour oss 0.86 (0.0) GAP 0.4 (0.03) (GAP) 0.6 (0.03) Hyohesis ess (5 er en riial values) + =.86 (3.84) Noes: No oinegraion -4.98* (-3.74) * indiaes signifiane a he 5 er en level of signifiane. The sandard errors are alulaed by he OLS sandard errors saisis by an esiae of (s / ) /. The F saisis are alulaed by ulilying he OLS F saisis by an esiae of (s / ). (Hailon (994) 60). A es saisi larger han he riial values (in absolue ers) rejes he lised hyohesis. All riial values are a he 5 er en level of signifiane. The null hyohesis ha + = was esed using a Wald es. The null hyohesis of no oinegraion was esed using he Engle-Granger (987) oinegraion es, wih he nuber of lags used in he residual regression deerined using sequenial ess. The riial values were obained fro Hailon (994). 7 Table 3: Coeffiien esiaes and hyohesis ess for equaion (0) Coeffiien esiaes (sandard errors) Error-orreion (0.) Ior ries 0.6 (0.03) Uni labour oss 0.84 (0.03) GAP 0.5 (0.06) (GAP) 0. (0.03) s (Ior ries) 0.04 (0.03) Hyohesis ess (5 er en riial values) + = 0.0 (3.84) No serial orrelaion 5.7 (9.49) Norally disribued residuals 0.58 (5.99) No heeroskedasiiy 3.39* (8.3) Noes * indiaes signifiane a he 5 er en signifiane level. A es saisi larger han he riial values (in absolue ers) rejes he lised hyohesis. All riial values are a he 5 er en level of signifiane. The null hyohesis of no serial orrelaion was esed using he Breush-Godfrey es. The lag lengh for his es was se o four. The null hyohesis of noral residuals was esed using he Jarque-Berra es. The riial values were obained fro Hailon (994). The null hyohesis of no heeroskedasiiy was esed using he Whie es. To oensae for he reored heeroskedasiiy, he OLS sandard errors have been adjused using he Whie ovariane adjusen aording o he following equaion: W T ( X X ) T k T u x x ( X X )

11 8 9 Daa Aendix: Table A - Daa series deails Table A suarises he series used in his analysis. All daa are a a quarerly frequeny. The sale eriod was 989Q o 00Q. Series Series nae Deails ode Ior ries Log(Ior rie index for oal erhandise iors) + ariff + x. See seion 3 for exlanaion and derivaion of x ariff (Cusos duy)/(value of oal erhandise iors) Consuer ries Log(CPI ex ineres and GST) GAP Ouu ga Ouu ga aken fro Reserve Bank of New Zealand Augus 00 rojeion ul Uni labour oss The offiial uni labour os series for New Zealand (Labour Cos Index) only begins in 99Q4. Therefore, a roxy series for he annual growh rae of uni labour oss bak o 989Q was onsrued by subraing annual roduiviy growh fro annual noinal wage growh. The esiaed annual growh rae series for uni labour oss was hen obined wih he five os reen observaions (000Q o 00Q) for he offiial Labour Cos Index o rodue a levels series of Uni Labour Coss (ULC). Then ul = Log(ULC ) ul ul -4 (Log(Wage ) Log(Wage -4 )) (Log(Produiviy ) Log(Produiviy -4 )) Wage Seasonally adjused average hourly earnings ordinary ie rivae seor Quarerly Eloyen Survey Produiviy (GDP/hours worked) run hrough a Hodrik- Preso filer wih =,600 GDP Seasonally adjused real GDP oal roduion GDP fro Naional Aouns Hours worked Seasonally adjused aual weekly hours worked Household Labour Fore Survey Labour Cos Index Seasonally adjused oal salary and wage raes rivae seor Labour Cos Index Referenes Beehey, Meredih, Nargis Bharuha, Ada Cagliarini, David Gruen and Chrisoher Thoson (000), A sall odel of he Ausralian Maroeonoy, Reserve Bank of Ausralia Disussion Paer, RDP Coe, David and C John MDero (997), Does he ga odel work in Asia? IMF Saff Paers, 44, Debelle, Guy and Jenny Wilkinson (000), Inflaion argeing and he inflaion roess: Soe lessons fro an oen eonoy, Reserve Bank of Ausralia aer for enral bank of Chile onferene. de Brouwer, Gordon and Neil Erisson (995), Modelling inflaion in Ausralia, Reserve Bank of Ausralia Disussion Paer, RDP950. Dwyer, Jaqueline, Chrisoher Ken and Andrew Pease (993), Exhange rae ass-hrough: The differen resonses of iorers and exorers, Reserve Bank of Ausralia Disussion Paer, RDP9304. Dwyer, Jaqueline and Riky La (994), Exlaining ior rie inflaion: A reen hisory of seond sage ass-hrough, Reserve Bank of Ausralia Disussion Paer, RDP9407. Dwyer, Jaqueline and Kenneh Leong (00), Changes in he deerinans of inflaion in Ausralia, Reserve Bank of Ausralia Disussion Paer, RDP00-0. Engle, Rober and Clive Granger (987), Coinegraion and error orreion: Reresenaion, esiaion, and esing, Eonoeria, 55, Gruen, David and Kenneh Leong (00), Where has all he asshrough gone, long ie assing? Reserve Bank of Ausralia unublished eo.

12 0 Hailon, Jaes (994), Tie series analysis, Prineon Universiy Press, New Jersey. MCarhy, Jonahan (000), Pass-hrough of exhange raes and ior ries o doesi inflaion in soe indusrialised eonoies, Federal Reserve Bank of New York. Phillis, Peer (99), Error orreion and long-run equilibriu in oninuous ie, Eonoeria, 59, 4, Reserve Bank of New Zealand (00), Marh 00 Moneary Poliy Saeen, 9-. Sok, Jaes and Mark Wason (993), A sile esiaor of oinegraing veors in higher order inegraed syses, Eonoeria, 6, 4, Taylor, John (000), Low inflaion, ass-hrough, and he riing ower of firs, Euroean Eonoi Review, 44, 7,