Motivated by stylized facts pointing to a dominant role of imported inputs in transmitting external price shocks to domestic prices, this paper zooms in to study the pass-through of imported input costs to domestic producer prices. Our approach constructs effective input price indices from sector-level price data combined with sector-level information on input-output linkages. Applying an error correction model specification to sector-level output and input prices, the long-run pass-through rate of effective imported input costs to domestic producer prices is estimated to be around 70 percent in Korea and almost 100 percent in selected European countries.
We are grateful to Woon Gyu Choi, Hyunjoon Lim, Huidan Lin, Kum Hwa Oh, Seryoung Park, Steve Phillips, Jerome Vandenbusshe, and participants at the 2016 KAEA Workshop in San Francisco and the Eastern Economic Association Meeting in DC for their very helpful comments. The views expressed in this paper are those of the authors and should not be attributed to the Bank of Korea or the International Monetary Fund.
Appendix: Selected Eurozone Countries
In this Appendix, we apply the same methodology to selected Eurozone countries – France, Germany, and the Netherlands. In principle, the methodology developed in the main text can be applied to any other country with a complete set of available data on the producer price index, import price index, unit labor cost, and the IO table, all at the sector level. We chose these three countries because they are the only countries in the Euro area with those sets of data readily available. As for the data for the selected European countries, the only difference is that all of them come from the publicly available Eurostat database; otherwise, they are processed in exactly the same way as is done for the Korean data.
Table 6 reports error correction model estimation results for these three countries in a pooled manner with country-sector-level fixed effects in columns (1) and (3) and the results of using the PMG estimator in columns (2) and (4). Table 7 checks the robustness by including additional lagged terms.
|Error correction coeff||−0.045***||−0.062***||−0.045***||−0.062***|
|Prob > χ2||1.000||1.000|
This table reports the baseline error correction model estimation results for three European countries (France, Germany, and the Netherlands) in a pooled manner. The dependent variable in columns (1)–(4) is the country-sector-level monthly producer price (PPI) inflation. Independent variables include country-sector-level monthly effective PPI inflation (EDOM), monthly effective import price inflation (EIMP), and the error correction term. Columns (3) and (4) also include country-sector-level monthly effective unit labor cost inflation (EULC). Columns (1) and (3) report dynamic fixed effects estimation results, whereas columns (2) and (4) report pooled mean group estimation results. Estimates on the error correction coefficient and p-values from the Hausman test are reported at the bottom of the table. Robust standard errors are in parentheses. Significance: *10 percent; **5 percent; ***1 percent.
|Δln_EIMPit − 1 (SR)||0.144***||0.181*||0.144***||0.179*|
|Δln_EDOMit − 1 (SR)||0.333*||0.046||0.333*||0.045|
|Δln_EULCit − 1 (SR)||0.001||-0.011|
|Error correction coeff||−0.044***||−0.060***||−0.044***||−0.059***|
|Prob > χ2||1.000||1.000|
This table checks the robustness of the baseline error correction model estimation results for three European countries (France, Germany, and the Netherlands). The dependent variable in columns (1)–(4) is the sector-level monthly producer price (PPI) inflation. Independent variables include sector-level monthly effective PPI inflation (EDOM), monthly effective import price inflation (EIMP), sector-level monthly effective unit labor cost inflation (EULC) and their one-period lagged terms as well as the error correction term. Columns (1) and (3) report dynamic fixed effects estimation results, whereas columns (2) and (4) report pooled mean group estimation results. Estimates on the error correction coefficient and p-values from the Hausman test are reported at the bottom of the table. Robust standard errors are in parentheses. Significance: *10 percent; **5 percent; ***1 percent.
Several things stand out. First, comparing columns (1) and (2) to columns (3) and (4), it is obvious that the effective unit labor cost variable does not play any role in these countries, possibly reflecting noisier measures or limited variation in the series. Second, unlike the earlier results from the Korean data, the results from the DFE estimator and those from the PMG estimator tend to diverge more significantly, but the Hausman test statistic still supports the validity of the DFE estimator. Third, considering the suggested preference toward the DFE estimator, we note that the estimated cost pass-through coefficients from the DFE estimator in Eurozone countries tend to be significantly larger than those in Korea; the degree of short-run cost pass-through from imported inputs is around 90 percent, and the long-run coefficient is almost 1, suggesting near-perfect cost pass-through in the long run. Although the short-run cost pass-through of domestic inputs is somewhat lower than that for imported inputs at 56 percent, near-perfect pass-through of domestic inputs in the long run cannot be rejected either. Lastly, reflecting the second and the third facts above, the speed of the adjustment is also about three times bigger than that of Korea, implying faster adjustments of producer prices toward the long-run relationship with input prices.
This exercise demonstrates the generalizability of the methodology employed in the paper, but at the same time, it suggests substantial heterogeneity in the degree of import price pass-through across countries. Such heterogeneity potentially reflects different market structures. It is perhaps not surprising to find more flexible price adjustment dynamics in these European countries than in Korea, as it is conceivable that this systematic difference might stem from higher competition and more flexible market. We leave the question for future study.
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