Non-technical summary
Since the start of Stage III of the European Monetary Union (EMU) in January 1999, the euro
area has been subject to a large number of external shocks such as a significant increase in
energy prices, substantial fluctuations in its effective exchange rate and, more recently, a
strong increase in non-energy commodity prices. Such movements can generally be expected
to impact, inter alia, significantly on price developments. So far, the literature has covered the
impact of exchange rates on headline and core inflation in the euro area or a number of euro
area countries (see for example, Gagnon and Ihrig (2004), Choudhri et al. (2002), Choudhri
and Hakura (2002), Faruqee (2006), Hahn (2003), Hüfner and Schroder (2002), Campa and
Gonzalez Minguez (2006), Campa and Goldberg (2006a and b), McCarthy (2000) and Bailliu
and Fujii (2004)). The question how euro area prices, foremost consumer prices, react to a
change in oil prices has been analysed primarily in the context of macro-econometric models
such as the ECB AWM, the Quest Model of the European Commission, OECDs interlink and
the NiGEM. Quite a number of recent studies have looked at the possibility of a change in the
impact of exchange rates (see for example Bussière and Peltonen (2008), Campa and
Goldberg (2006b) and Gagnon and Ihrig (2004)).
Overall, only few studies have analysed a pricing chain, i.e. the transmission of such shocks
via production costs to consumer prices (see for example Hahn (2003), Faruqee (2006) and
McCarthy (2000), who conduct the analysis within a VAR approach). None of the studies has,
to our knowledge, considered the transmission via different sectors in such a pricing chain
framework, particularly regarding the difference in the transmission between tradable (goods)
and non-tradable (services) prices. Hahn (2007) has analysed the impact of exchange rates on
sectoral producer prices without, however, estimating a pricing chain framework.
The purpose of this paper is to analyse in a mark-up framework the pass-through of external
shocks (commodity prices, split into energy and non-energy commodities, and the exchange
rate) to the main components of the producer price index and the Harmonised Index of
Consumer Prices excluding energy and unprocessed food (HICPX). The general idea is to
link movements in prices at the different stages of production as, in theory, a firm sets its
prices as a mark-up over (marginal) production costs. Consequently, for a given profit
margin, an increase in the price of a material input will push costs up, giving a firm an
incentive to raise its price. Thus, in general, a natural link between movements of raw
material prices and exchange rates, producer prices and consumer prices exists.
The analysis of the pricing chain for producer and consumer prices reveals significant inter-
linkages between the different price stages in the euro area, thereby demonstrating that
ECB
Working Paper Series No 1104
November 2009∣ 5