EXCHANGE RATE PASS-THROUGH IN A SMALL OPEN ECONOMY: A STRUCTURAL VAR APPROACH

Studying exchange rate pass-through in Turkey for the period of 2006m1-2015m6, we first show that the commonly used recursive VAR model generates unrealistic dynamics like effects of domestic variables on external variables in small open economies and biased estimates. Bias comes from unrealistic decline in energy prices in response to depreciation of currency. However, a more realistic structural VAR model suitable for small open economies generates more sensible dynamics and suggests a higher pass-through than the recursive VAR model. Overall, our analysis demonstrates the importance of using a more realistic model setup and checking the relationships across variables when estimating ERPT in small open economies.