Abstract
After decades of stable and low levels of inflation throughout the world, the recent global upsurge in inflation has once again triggered extensive debate among economists about the underlying reasons for the rising trend in inflation. This study aims to contribute to this ongoing discussion by exploring a potential channel that could be fundamental to our understanding of the high inflation levels common across a large number of countries.
Drawing upon a rich historical dataset spanning from 1961 to 2023 and employing a random effects panel probit model, our research reveals that the nominal exchange rate depreciation emerges as a strong predictor of “high inflation” episodes across different economies and time periods. Notably, this predictive capability extends to countries with varying income levels, with high-income, upper-middle-income, and lower-middle-income nations exhibiting success rates of 70%, 77%, and 63%, respectively, in forecasting “high inflation” based solely on exchange rate depreciation. Furthermore, food and energy prices also emerge as other important contributors to inflation.
These findings have important implications for recognizing exchange rate depreciation as a vital early warning signal for high inflation not only facilitates more timely and effective policy interventions but also emphasizes the critical role of historical exchange rate dynamics and supply-side factors in comprehending the complexities of “high inflation.”