Pricing Behavior and Exchange Rate: Evidence from Iran Consumer Prices

This paper presents novel evidence on the effect of exchange rate on pricing behavior. After an aggregate shocks, the information content of various nominal variables diverges. Consequently, price setters adjust prices based on a combination of relevant macro variables, including inflation, expected inflation, and exchange rate growth. We use a comprehensive dataset of Iran’s consumer prices covering the period 2006-2022, encompassing different macroeconomic conditions, low and high inflation, stable and volatile exchange rates. We find the following key results: (1) Pricing behavior exhibits a weaker response to exchange rate growth compared to inflation. (2) The effect of exchange rate growth can be separated to expected inflation and cost shocks and our evidence indicates that the cost shock effect is not canceled out by expected inflation mechanism (3) Expected inflation impacts pricing behavior, and this effect remains distinct from the influence of actual inflation. (4) Expected exchange rate growth increases absolute size of price changes, but does not increases frequency of price changes (5) The effect of provincial inflation on pricing behavior differs from national inflation.