The Effect of Supply Shock and Demand Shock on the Foreign Currencies Exchange Rate Pass – Through to Price Index in Jordan (1990 –2013)

Abstract

This study aims to identify the variables ( supply and demand shocks) affecting foreign currencies exchange rate pass–through to price index in Jordan , over the years ( 1990- 2013) to determine their effect and transfer to domestic price index.To achieve this goal, the researcher modifying (McCarthy) Model; examining the main hypotheses of the study which is the measurement of the effect of exchange rate pass-through on price index; and partial hypotheses which discusses supply shock (oil prices) and demand shock (money supply) impact on price index.Using VAR model to examine these hypotheses, the results of variance components and impulse response revealed a strong relationship between the movement of foreign currencies exchange rates and the price index in Jordan; and the response of wholesale price index to these movements was greater than the response of consumer price index.The results as well showed a strong and positive effect of demand and supply shocks on the transfer of the movement of foreign currencies exchange rates to price index in Jordan. These effects were stable in first and second period and increased in the next periods. Level of exports concentration, imports composition, difference between domestic and global inflation rates, lack of flexibility of the wages and prices, capital movements, and markets integration; all these had a role in speeding the transfer of exchange rates movements to the price index in Jordan.

Keywords: Exchange Rate Pass Through, Nominal Effective Exchange Rate (NEER), Supply shock, Demand shock, VAR analyses, Auto regression.