Abdi, Abdika i Hassan; Wa same, Abdimalik Ali; Sheik-Ali, Ib ahim Abdukadi
A icle
Tes ing he non-linea i ies o exchange a e pass- h ough
in Somalia: does dolla iza ion a ec consume p ices?
Cogen Economics & Finance
P o ided in Coope a ion wi h:
Taylo & F ancis G oup
Sugges ed Ci a ion: Abdi, Abdika i Hassan; Wa same, Abdimalik Ali; Sheik-Ali, Ib ahim Abdukadi
(2024) : Tes ing he non-linea i ies o exchange a e pass- h ough in Somalia: does dolla iza ion
a ec consume p ices?, Cogen Economics & Finance, ISSN 2332-2039, Taylo & F ancis, Abingdon,
Vol. 12, Iss. 1, pp. 1-14,
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Tes ing he non-linea i ies o exchange a e pass-
h ough in Somalia: does dolla iza ion affec
consume p ices?
Abdikafi Hassan Abdi, Abdimalik Ali Wa same & Ib ahim Abdukadi Sheik-Ali
To ci e his a icle: Abdikafi Hassan Abdi, Abdimalik Ali Wa same & Ib ahim Abdukadi
Sheik-Ali (2024) Tes ing he non-linea i ies o exchange a e pass- h ough in Somalia: does
dolla iza ion affec consume p ices?, Cogen Economics & Finance, 12:1, 2344720, DOI:
10.1080/23322039.2024.2344720
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DEVELOPMENT ECONOMICS | RESEARCH ARTICLE
Tes ing he non-linea i ies o exchange a e pass- h ough in Somalia:
does dolla iza ion a ec consume p ices?
Abdika i Hassan Abdi
a
, Abdimalik Ali Wa same
b
and Ib ahim Abdukadi Sheik-Ali
b
a
Ins i u e o Clima e and En i onmen , SIMAD Uni e si y, Mogadishu, Somalia;
b
Facul y o Economics, SIMAD Uni e si y,
Mogadishu, Somalia
ABSTRACT
O e he pas h ee decades, Somalia’s economic landscape has wi nessed a no iceable
dependence on impo ed goods. The exchange a e was un egula ed owing o he
collapse o he coun y’s cen al bank. This un egula ed en i onmen has in oduced
signi ican ola ili y in exchange a es, p o oundly impac ing consume p ices and
os e ing a p e alen shi owa ds he u iliza ion o he US dolla in economic ansac-
ions. Hence, his unde aking del es in o he asymme ic e ec s o exchange a es on
consume p ices in he p esence o dolla iza ion in Somalia om 1995 o 2019.
Employing bo h linea and nonlinea au o eg essi e dis ibu ed lag (NARDL) coin eg a-
ion me hodologies, we explo e he sho - un and long- un dynamics be ween
exchange a es and consume p ice le els. The long- un empi ical esul s om he
NARDL demons a e asymme ical coin eg a ion be ween he un egula ed exchange
a e and in la ion in Somalia. Bo h app ecia ion and dep ecia ion o exchange a es
exe di e ing impac s on consume p ices, wi h dep ecia ion exhibi ing a mo e p o-
nounced e ec . In addi ion, he e idence sugges s ha he exchange a e pass- h ough
is incomple e in Somalia ega ding i s inelas ic coe icien . Oil p ices exhibi a subs an-
ial and s a is ically signi ican associa ion wi h in la ion, bo h in he long- un and
sho - un, while GDP emains inconsequen ial. In he sho - un, he mos ema kable
ou come indica es ha dolla iza ion signi ican ly con ibu es o mi iga ing in la iona y
p essu es. Based on ou empi ical insigh s, he cen al bank should enhance egula o y
o e sigh o he o eign exchange ma ke by s ic ly con olling and p ohibi ing he
issuance o coun e ei bankno es o achie e p ice s abili y.
IMPACT STATEMENT
This esea ch comp ehensi ely analyzes he complex dynamics be ween exchange a e
luc ua ions and consume p ices in Somalia, e ealing a p onounced asymme y.
Th ough sophis ica ed modeling, he s udy demons a es ha exchange a e dep ecia-
ions signi ican ly impac in la ion mo e han app ecia ions, a inding c i ical o e ec -
i e mone a y policy in dolla ized economies like Somalia. The indings indica e he
need o obus egula o y amewo ks o mi iga e he ad e se e ec s o exchange a e
luc ua ions on he economy. This wo k is ins umen al o policymake s, p o iding e i-
dence-based ecommenda ions o enhance egula o y measu es aimed a s abilizing
p ices and managing in la iona y p essu es. Addi ionally, i con ibu es o he b oade
economic li e a u e by de ailing he unique challenges and s a egies ele an o man-
aging economies wi h signi ican dolla iza ion.
ARTICLE HISTORY
Recei ed 11 Decembe 2023
Re ised 2 Ap il 2024
Accep ed 13 Ap il 2024
KEYWORDS
In la ion; dolla iza ion; oil
p ices; exchange a e pass-
h ough; NARDL; Somalia
REVIEWING EDITOR
Goodness Aye, Uni e si y o
Ag icul u e, Maku di Benue
S a e, Nige ia
SUBJECTS
In e na ional Finance;
Economic Fo ecas ing;
Econome ics;
Mac oeconomics;
Economics; In e na ional
Economics
1. In oduc ion
Unde s anding domes ic p ice changes in esponse o exchange a e mo emen s has become c ucial o
mone a y au ho i ies o achie e p ice s abili y. The magni ude o exchange a e pass- h ough (ERPT) is a
signi ican de e minan o he le el o exchange a es, balance o paymen s adjus men pa e ns, and
CONTACT Abdika i Hassan Abdi [email p o ec ed] Ins i u e o Clima e and En i onmen , SIMAD Uni e si y, Mogadishu,
Somalia.
ß2024 The Au ho (s). Published by In o ma UK Limi ed, ading as Taylo & F ancis G oup
This is an Open Access a icle dis ibu ed unde he e ms o he C ea i e Commons A ibu ion License (h p://c ea i ecommons.o g/licenses/by/4.0/), which
pe mi s un es ic ed use, dis ibu ion, and ep oduc ion in any medium, p o ided he o iginal wo k is p ope ly ci ed. The e ms on which his a icle has been
published allow he pos ing o he Accep ed Manusc ip in a eposi o y by he au ho (s) o wi h hei consen .
COGENT ECONOMICS & FINANCE
2024, VOL. 12, NO. 1, 2344720
h ps://doi.o g/10.1080/23322039.2024.2344720
inancial s abili y (Dela e & L
opez-Villa icencio, 2012). Since global ade is highly in e connec ed, an
exchange a e shock is expec ed o a ec he domes ic p ice o impo ed goods (Abdi e al., 2023). This
shi is passed on o p oduce and consume p ices. E en hough he app ecia ion o local cu ency
educes he p ices o impo ed goods, he weakening o he cu ency inc eases hese p ices, which leads
o highe consume p ices (Dela e & L
opez-Villa icencio, 2012). The nominal exchange a e a ec s
domes ic p ice le els o aded goods p ima ily h ough di ec and indi ec channels (Dob ynskaya &
Le ando, 2005; Jiang & Kim, 2013). The di ec e ec o exchange a e mo emen s is ansmi ed h ough
he p ices o inal goods. Whene e he p opo ion o he impo ed baske o i ems is la ge , he in lu-
ence o he exchange a e on p ices is mo e signi ican (Ga cia & Res epo, 2001). The indi ec channel is
con eyed h ough he p oduc ion cos s o en e p ises ha ely on impo ed inpu s o hei inal p od-
uc s. In his ega d, he ERPT in luences he company’s cos s uc u e, in luencing agg ega e demand le -
els and eal incomes (Ha a e al., 2015; Jiang & Kim, 2013). Co espondingly, he ex en o exchange a e
changes e lec ed in domes ic in la ion emains a majo issue o mone a y au ho i ies in small open
economies (Balcila e al., 2019).
Typically, he deg ee o exchange a e pass- h ough o in la ion anges om ze o o comple e. The
ex en o pass- h ough depends on he i ms’p icing beha io wi h espec o exchange a e changes
(Helmy e al., 2018). Ze o pass- h ough exis s when o eign i ms p e e o keep hei ma kups
unchanged by se ing he p ices o expo ed goods in he des ina ion ma ke ’s cu ency, known as local
cu ency p icing (LCP) (Jiang & Kim, 2013). Comple e pass- h ough, on he o he hand, occu s when
en e p ises choose o ully ansmi exchange a e a ia ions o he selling p ice o hei goods, espe-
cially when p ices a e es ablished in he cu ency o he p oduce s, e e ed o as p oduce cu ency p ic-
ing (PCP). Theo e ically, he pass- h ough o he exchange a e o domes ic p ices is comple e, ha is,
equal o one. On he con a y, he empi ical e idence asce ains ha incomple e pass- h ough is a com-
mon phenomenon (A on e al., 2014; de Mendonc¸a & Tibe o, 2017; Helmy e al., 2018; Jiang & Kim,
2013). The majo i y o businesses use a combina ion o bo h s a egies, which is called pa ial pass-
h ough because, in a compe i i e en i onmen , i ms canno ully ansmi ERPT o impo p ices (An &
Wang, 2012; Dela e & L
opez-Villa icencio, 2012). The declining deg ee o ERPT in many de eloped and
de eloping coun ies can be a ibu ed o declining in la ion le els (Soon e al., 2018).
The exis ing empi ical s udies demons a e ha he dispa i y in he le el o pass- h ough ac oss di e -
en coun ies is mainly due o disc epancies in he mone a y policies adop ed. In a g oundb eaking
pape , Taylo (2000) con ends ha he ex en o pass- h ough is minimal in an en i onmen cha ac e -
ized by lowe and mo e s able in la ion. Taylo ’s hypo heses exhibi ha ERPT esul s om con inual
p ice changes, which end o decline in an in la iona y en i onmen wi h mo e c edible mone a y policy.
The li e a u e has documen ed ha domes ic in la ion is sligh ly suscep ible o exchange a e luc ua-
ions in many ad anced economies. Dela e and L
opez-Villa icencio (2012) indica e ha he a e age
pass- h ough in de eloped coun ies is close o ze o. The mone a y au ho i ies can exe cise independ-
ence in he mone a y policy se ing, and an in la ion- a ge ing s a egy is easible in low ERPT ci cum-
s ances (Choudh i & Haku a, 2006). Unlike he expe ience o de eloped coun ies, in la ion shocks c ea e
emendous mac oeconomic ulne abili ies in de eloping coun ies because o an uns able mone a y
en i onmen , which esul s om inc eased exchange a e dep ecia ion and capi al ligh (de Mendonc¸a
& Tibe o, 2017). The de eloping coun ies a e ulne able o exchange a e shocks because impo ed
goods accoun o a conside able sha e o in e media e and consume goods.
The Cen al Bank o Somalia has been he sole au ho i y o egula e and moni o he Somali shilling
(SOS), he coun y’s de ac o cu ency, which was mo e s able and c edible be o e he collapse o he
Somali Republic. Du ing his ime, he alue o he SOS agains he US dolla was main ained a a ound
7 shillings o oughly en yea s (No , 2015). The SOS was pegged o he SDR ins ead o he US dolla in
he 1980s, when he dual exchange a e sys em was uni ied (Wo ld Bank, 1983). Howe e , ollowing he
o e h ow o he cen al go e nmen and he collapse o he inancial sys em in 1991, he o eign
exchange ma ke in Somalia has been ope a ing wi hou he egula ion o he mone a y au ho i ies in
he pos -con lic pe iod (Lu he , 2012). This caused an inc eased supply o coun e ei cu ency and he
eme gence o specula o s who d as ically d opped o inc eased he alue o he SOS based on hei
s a egy o ea n eno mous p o i s (No , 2015). This coe ced he SOS o be a ola ile cu ency. This de el-
opmen implied ha Somalia’s in la ion a e eached i s highes le el in 2008 when he na ional
2 A. H. ABDI ET AL.
cu ency dep ecia ed 54 pe cen agains he US dolla (No , 2012). A ecen epo om he Somalia
Na ional Bu eau o S a is ics (2022) shows ha he consume p ice index (CPI) inc eased by 6.98% in
June 2022 o 134.77 agains 125.97 in he same mon h o he p eceding yea .
Gi en he ola ili y o exchange a es, he dep ecia ion o he Somali Shilling, and a p e ailing lack o
public con idence, local cu ency holde s inc easingly op o he US dolla o mi iga e he po en ial e o-
sion o alue in hei domes ic cu ency. The coun y’s ex ensi e use o he US dolla gained p ominence
du ing he 1990s, pa icula ly in he a e ma h o he ci il wa . The dolla iza ion p ocess in Somalia
occu ed g adually as businesses and indi iduals began o p e e using he US dolla o a ious ansac-
ions due o i s s abili y and wide accep ance in in e na ional ade. In Somalia, impo ed goods cons i-
u ed 83.5 pe cen o he GDP in 2020, indica ing i s signi ican dependence on o eign ade (Abdi
e al., 2024). Fu he mo e, Musoke (2017) posi s ha indica o s o a dolla ized economy include banks
o e ing loans and accep ing deposi s in dolla s, goods and se ices p iced in US dolla s, and ansac-
ions p edominan ly conduc ed in dolla s. This is e iden in Somalia, whe e all go e nmen paymen s
and inancial ac i i ies a e denomina ed in dolla s. Fu he mo e, a ious ansac ions such as household
bills, ui ion ees, axes, and go e nmen sala ies a e exclusi ely disbu sed in US dolla s, while he SOS
emains p e alen in small-scale ansac ions, pa icula ly in u al a eas o li es ock and ag icul u al ma -
ke s (No e al., 2020). A signi ican ac o sus aining he SOS in he economy is he imp ac icali y o
using he US dolla o small ansac ions due o i s indi isibili y.
Many s udies ha e been conduc ed in a ious coun ies concen a ed on he e ec s o cen al bank
c edibili y and in la ion expec a ions on he ERPT-in la ion channel (A on e al., 2014; Choudh i &
Haku a, 2006; de Mendonc¸a & Tibe o, 2017; Helmy e al., 2018; Jun ila & Ko honen, 2012; Soon e al.,
2018). Acco ding o Musoke (2017), since many de eloping coun ies ace uns able mone a y en i on-
men s, dolla iza ion is a signi ican ac o ha in luences he exchange a e and in la ion linkage.
Despi e he emendous expansion o ERPT li e a u e, no empi ical s udy has in es iga ed he e ec o
dolla iza ion on he ERPT-in la ion ela ionship. Gi en his backg ound, his s udy aims o in es iga e he
asymme ic e ec s o he exchange a e on in la ion in Somalia om 1995 o 2019 by inco po a ing he
ole o dolla iza ion. Wi h a ew excep ions, ea lie esea ch on he in luence o ERPT on consume p ices
assumed a linea in e ac ion be ween exchange a e and in la ion. Acco ding o he symme ic assump-
ion, exchange a e app ecia ions and dep ecia ions a e passed o he inal p ice o goods in an equi a-
len magni ude. The e o e, Baha umshah e al. (2017) sugges ha using symme ic equa ions can
d as ically dis o es ima ions when asymme ic pass- h ough is p esen . Using he NARDL model, hey
con i m ha dep ecia ion is ca ied h ough p ices mo e han app ecia ion. Acco ding o Dela e and
L
opez-Villa icencio (2012), he NARDL has he bene i o allowing us o de e mine bo h he dynamic
sho - un and long- un asymme ies in he exchange a e-in la ion connec ion. Ano he c ucial ad an-
age is ha i pe o ms be e wi h small samples compa ed o o he coin eg a ion es s (Pesa an e al.,
2001).
The e o e, his a icle con ibu es o he li e a u e in a ious ways: Fi s , he s udy examines he ERPT-
in la ion nexus in Somalia, p esen ing he i s empi ical e idence o he non-linea dynamic sho - and
long- un pass- h ough coe icien s on consume p ices. The esea ch sheds ligh on how exchange a e
luc ua ions impac domes ic p ices du ing he s udy pe iod. Second, unlike p e ious esea ch, his s udy
del es in o he impac o dolla iza ion on he ERPT-in la ion linkage. An issue ha emains o be
add essed is he e ec o dolla iza ion on consume p ices, which is a signi ican ac o in coun ies wi h
uns able mone a y en i onmen s. Gi en ha many de eloping economies a e o icially o uno icially
dolla ized, he s udies in es iga ing whe he dolla iza ion expands o dampens he ERPT-in la ion pa h-
way a e limi ed. Thi d, unde s anding he dynamics o exchange a es, dolla iza ion, and in la ion o e s
aluable insigh s o policymake s in adjus ing mone a y policy p ope ly. The indings can guide he o -
mula ion o mo e e ec i e mone a y policies, enabling au ho i ies o espond app op ia ely o economic
challenges s emming om exchange a e luc ua ions and dolla iza ion.
The emainde o he a icle is s uc u ed as ollows: he second sec ion p o ides a li e a u e e iew
on ERPT and in la ion; he hi d sec ion ou lines he da a and econome ic me hodology; he ou h sec-
ion p esen s empi ical esul s and discussion; and he concluding sec ion summa izes he indings and
sugges s policy ecommenda ions.
COGENT ECONOMICS & FINANCE 3
2. Li e a u e e iew
The signi icance o he exchange a e pass- h ough (ERPT) mechanism o p ice s abili y has been a subjec o
in e es o esea che s in he pas ew decades. A la ge body o p io s udies in es iga ed he e ec s o ERPT
on p ices in eme ging ma ke s. The p ice changes a e a ibu ed o ac o s including changes in nominal
exchange a es, GDP g ow h, mone a y policy, and oil p ices. The empi ical e idence concludes wi h mixed
indings using a ious es ima ion echniques and mac oeconomic ac o s ac oss di e en coun ies and
egions. This sec ion e iews he pas li e a u e in es iga ing he connec ion be ween ERPT and in la ion.
A conside able numbe o he p io s udies p esen ha p ice le els eac di e en ly o app ecia ions
and dep ecia ions o e he sho - un and long- un. Dela e and L
opez-Villa icencio (2012) in es iga ed
he nonlinea e ec o exchange a e a ia ions on p ices by adop ing a ma kup model o p ices in ou
pa icula ad anced economies. The es ima ed indings om asymme ic coin eg a ing models demon-
s a ed ha p ices espond dispa a ely o app ecia ions and dep ecia ion o e he long- un, indica ing
ha dep ecia ions pass h ough mo e s ongly han do app ecia ions in all coun ies in he sample.
Acco ding o Baha umshah e al. (2017), consume p ices espond asymme ically o exchange a e shi s
in bo h he sho - and long- un. The au ho s obse ed ha he sho - un ERPT o in la ion is ela i ely
smalle , while he long- un consume p ices espond mo e signi ican ly o dep ecia ion han app ecia ion.
Con e sely, P zys upa and W
obel (2011) u ilized he New-Keynesian Phillips Cu e o assess he linea i y
o ERPT o p ice le el using qua e ly da a be ween 1997 and 2008 in Poland. Thei symme ic inding
e eals ha he ERPT ends o al e alongside he business cycle, al hough no e idence o an asymme ic
eac ions o app ecia ion and dep ecia ion was obse ed. The es ima ions o consume p ice eac ions
show ha ERPT is ela i ely minimal amid con ac ions and mo e p onounced du ing expansions.
Likewise, se e al s udies ha e employed panel da a me hodologies o in es iga e he ERPT phenom-
enon in agg ega e impo p ices. Based on an asymme ic app oach, Jun ila and Ko honen (2012)
obse ed ha pass- h ough coe icien s a e dependen on he in la ion policies o nine OECD coun ies.
The au ho s demons a ed ha pass- h ough is pa ially and a o ably associa ed wi h he in la iona y
egime o he impo ing coun y. Co espondingly, Soon e al. (2018) ound an asymme ic associa ion
among ERPT and in la ion ola ili y o six Asian coun ies adop ing qua e ly da a om 1980 o 2014.
The s udy con i med majo dispa i ies in he ERPT le els be ween he Asian coun ies ha use in la ion
a ge ing (IT) and hose ha do no . The pass- h ough is almos comple e when in la ion ola ili y is
highe . Ben Cheikh and Raul (2016) p esen ed a signi ican and a o able connec ion be ween pass-
h ough and he a e age in la ion a e ac oss 12-eu o a ea (EA) economies. The e idence sugges s ha
he mone a y union p ocess has esul ed in a ce ain deg ee o mac oeconomic homogenei y ac oss he
EA coun ies. On he con a y, An (2006) es ed he le el o ERPT a di e en dis ibu ion s ages o eigh
majo indus ial coun ies. Based on he dis ibu ion chain, he a e o pass- h ough dec eases, and he
amoun o ime equi ed o ull pass- h ough p olongs. Mo eo e , he s udy disco e ed ha a smalle
economy wi h a highe impo a io, s eady exchange a es, mo e appa en mone a y shocks, an expand-
ing in la ion a e, and low ola ile economic g ow h is associa ed wi h a highe pass- h ough coe icien .
Mone a y policy is conside ed wo hwhile in de e mining he ela ionship be ween ERPT and p ice
changes. Unde he in la ion- a ge ing egime, he li e a u e asse s ha ERPT o in la ion om impo p i-
ces is incomple e. Fo ins ance, A on e al. (2014) examined he impac o ERPT on impo p ices in Sou h
A ica using mon hly da a spanning om 1980 o 2009. The s udy disco e ed he exis ence o lowe pass-
h ough unde he in la ion- a ge ing egime using a ious coin eg a ion me hodologies. Fu he mo e,
pass- h ough dec eases wi h exchange a e ola ili y and inc eases wi h small app ecia ions. de Mendonc¸a
and Tibe o (2017) sugges ha a subs an ial le el o p ice s abili y in eme ging economies is a ibu able
o he c edibili y o hei cen al banks. Once mone a y au ho i ies commi o ixing in la ion expec a ions,
hey ea n c edibili y, elimina ing he pass- h ough e ec on in la ion. By he same oken, Balcila e al.
(2019) compa ed ERPT o p ices in Nige ia and Sou h A ica, e ealing ha ERPT is comple e in Nige ia bu
pa ial in Sou h A ica. No ably, p ices in Sou h A ica we e s ickie , indica ing he in luence o in la ion a -
ge ing and cen al bank c edibili y on ERPT. The impac o ou pu g ow h and oil p ices a ied be ween he
wo coun ies. Fu he mo e, Bangu a e al. (2012), Helmy e al. (2018), and Jiang and Kim (2013) employed
he S uc u al Vec o Au o eg ession (SVAR) model o es ima e he pass- h ough e ec s o exchange a e
changes on in la ion using di e en p ice indices. The indings emphasize ha he pass- h ough o p ices
4 A. H. ABDI ET AL.
was signi ican o he a ious p ice indices; howe e , i was incomple e. These s udies ou lined ha
exchange a e dep ecia ion is a po en ial and p ominen sou ce o in la ion o Egyp , Sie a Leone, and
China, espec i ely, which necessi a es he implemen a ion o a mone a y a ge ing amewo k.
Mo eo e , a subs an ial body o li e a u e explo es whe he a shi owa d a low-in la ion en i onmen
esul s in a educ ion in he ex en o which exchange a e mo emen s pass- h ough o consume p ices
(Bailliu & Fujii, 2004; Jimbo ean, 2013; Jun ila & Ko honen, 2012;L
opez-Villa icencio & Mignon, 2017). E en
hough s udies employed di e se echniques ac oss di e en egions, he ou comes indica e ha he ERPT
o p oduce and consume p ice le els has dec eased, a ibu able o s abiliza ion policies, in nume ous
eme ging and ad anced economies. Acco ding o Bailliu and Fujii (2004), ERPT dec eases when he mone -
a y policy egime changes and he en i onmen becomes low-in la iona y. Co espondingly, L
opez-
Villa icencio and Mignon (2017) augmen ed he adi ional bi a ia e o analyze he ex en o pass- h ough
on p ice le el by accoun ing o he mone a y s abili y o 14 de eloping coun ies. Consume p ices a e a
be e choice han impo p ices o gauge he impac o he in la ion en i onmen since he consequences
o ERPT on consume p ices a e mo e signi ican han impo p ices. Shin ani e al. (2013) p esen ha he
ERPT dec eases in he 1980s and 1990s a e ela ed o dec eased in la ion. Addi ionally, Jimbo ean (2013)
explo es whe he he exchange- a e pass- h ough es ima es ha e dec eased in esponse o a shi in he
in la ion en i onmen o 10 Cen al and Eas e n Eu opean coun ies. The au ho concluded ha a decline
in ERPT exis s only in he sho - un o impo p ices.
Recen e idence sugges s ha pass- h ough dispa a ely a ec s in la ion du ing highe o lowe
exchange a e ola ili y pe iods. As an illus a ion, Ozkan and E den (2015) employed di e se econome -
ic app oaches o analyze he ela ionship be ween ERPT and in la ion ac oss a ious coun ies. They
ound a signi ican dec ease in ERPT since he mid-1990s, wi h ERPT esponding posi i ely o in la ion
and he in la ion a e ola ili y bu nega i ely o exchange a e ola ili y, openness, and he ou pu gap.
In pa allel, da Sil a Co eay and Minellaz (2010) u ilized a Phillips cu e wi h a h eshold and ound ha
sho - un pass- h ough is mo e no able when he economy expe iences a apid expansion, he exchange
a e dep ecia es beyond a speci ic h eshold, and he exchange a e ola ili y is low. Simila ly,
Osabuohien e al. (2018) employed GARCH and VECM me hodologies o assess he deg ee o exchange
a e ola ili y and he impac o o icial and pa allel exchange a es on in la ion in Nige ia, u ilizing
mon hly da a om 2006 o 2015. Thei analysis indica es ha long- un exchange a e ola ili y subs an-
ially and posi i ely a ec s in la ion. Speci ically, he pa allel exchange a e exe s a sho - un pass-
h ough e ec on he p ice le el, while he o icial exchange a e in luences in la ion in he long- un.
Fu he s udies p esen ed ha ac o s such as ou pu g ow h, oil p ices, policy shocks, and in la ion
expec a ions a ec he ERPT and in la ion mechanism. Fo example, Ga cia and Res epo (2001) applied
linea quad a ic adjus men cos (LQAC) models o measu e ERPT and p ice le el using qua e ly da a o
Chile om 1986 o 2001. The indings s a e ha ERPT depends posi i ely on he ou pu gap. This sug-
ges s ha a nega i e ou pu gap has compensa ed o he in la iona y e ec s o exchange- a e dep eci-
a ion. Addi ionally, p oduc i i y lowe s in la ion and uni labo cos s, whe eas wages and o eign
exchange a es aise in la ion. Rega ding in la ion a ge ing, Nasi e al. (2020) used mon hly da a o
explo e he ERPT o in la ion expec a ions in he Czech Republic. The esul s om he NARDL amewo k
e eal ha ERPT has subs an ial e ec s on in la ion expec a ions. Co espondingly, Comunale and
Kuno ac (2017) employed VAR models o in es iga e he ERPT in he eu o a ea. They show ha pass-
h ough is no cons an o e ime and can be impac ed by he dis ibu ion o economic shocks ha
con ol exchange a e mo emen . The pass- h ough o impo p ices is highe han consume p ices in
he eu o a ea. Fu he mo e, Ha a e al. (2015) used qua e ly da a be ween 1982 and 2014 o explo e
whe he changing ERPT in Japan indica es changing p icing beha io . The es ima ions indica e ha ERPT
o consume and p oduce p ice indices has inc eased since he la e 2000s, p ima ily a ibu ed o he
heigh ened eliance on impo s in p oduc ion. A signi ican po ion o his ise is a ibu ed o he
heigh ened esponsi eness o in la ion o ma ginal cos s.
E en hough he g owing li e a u e deba ed he cen al ole o he mac oeconomic en i onmen , he
cen al bank’s c edibili y, and in la ion- a ge ing policies on he ERPT mechanism, hey igno ed he e ec
o dolla iza ion on consume p ices. The economic ac i i ies o many de eloping coun ies, including
Somalia, a e dolla ized mainly due o he dep ecia ion o he local cu ency. Li le is known abou
whe he dolla iza ion inc eases o dec eases he ERPT-in la ion nexus. Hence, he p esen s udy will
COGENT ECONOMICS & FINANCE 5
adop an asymme ic echnique o ill he gap in he li e a u e. I will pa e he way o he mone a y
au ho i ies o o mula e a sound mac oeconomic policy o con ol he e ec o ERPT on in la ion.
3. Me hodology
3.1. Da a and a iables
The s udy used annual ime se ies da a om 1995 o 2019 o e alua e he ERPT hypo hesis in he con-
ex o Somalia. The sample pe iod was selec ed because o he ollowing easons. Fi s , he d ama ic
dep ecia ion o he exchange a e du ing his pe iod can be a ibu ed o he collapse o Somalia’s inan-
cial ins i u ions ollowing he ous ing o he mili a y go e nmen in 1991. In addi ion, he coun y’s o -
eign exchange ma ke became un egula ed. Second, he economy became highly elian on impo ed
goods, which comp ised a signi ican sha e o he o e all economic ac i i y. Thi d, due o he massi e
dep ecia ion o he local cu ency, he economy became dolla ized du ing his pe iod. Hence, cap u ing
he consequences o dolla iza ion on consume p ices in Somalia is necessa y. The da a employed in his
s udy we e sou ced om he Uni ed Na ions S a is ical Di ision (UNSD), he Food Secu i y and Nu i ion
Analysis Uni (FSNAU), and Fede al Rese e Economic Da a (FRED).
The explained a iable is he consume p ice index (CPI), a p oxy o in la ion, whe eas he explana o y
a iables a e he un egula ed nominal exchange a e, ou pu g ow h, oil p ice, and dolla iza ion. The oil
p ice and ou pu g ow h a e measu ed o he B en c ude oil p ice (Wa same, 2022) and eal g oss
domes ic p oduc (Wa same e al., 2022). The s udy also u ilizes he nominal exchange a e as a p oxy o
he exchange a e, consis en wi h ample p e ious s udies (Helmy e al., 2018; P zys upa & W
obel, 2011;
Soon e al., 2018). Dolla iza ion is c ea ed as a dummy a iable. I was gi en alues o “1”, which shows
he p esence o dolla iza ion, and “0”, which indica es he absence o dolla iza ion (Pa k & Son, 2020).
Somalia’s economy became dolla ized in 2000. Be o e 2000, he dummy a iable o dolla iza ion was
gi en “0”; om 2000 onwa ds, i was gi en “1”.Table 1 summa izes he desc ip ion o he a iables,
uni s o measu emen , and hei sou ces. To in e p e he s udy esul s as elas ici ies, we con e ed all
he a iables in o na u al loga i hms excep o dolla iza ion.
3.2. The econome ic model
Nume ous empi ical s udies ha e u ilized a Phillips cu e model, wi h mino adjus men s, o in es iga e
he empi ical ela ionship be ween exchange a e luc ua ions and in la ion. Conside ing his, he model
speci ica ion employed in his s udy aligns wi h p e ious esea ch by Balcila e al. (2019) and
Baha umshah e al. (2017), inco po a ing nominal exchange a e, ou pu g ow h, and oil p ice a iables.
Addi ionally, o inco po a e dolla iza ion in o he model, his s udy ollows he app oach ou lined by
Pa k and Son (2020). The e o e, he model speci ica ion o he s udy is exp essed as ollows.
CPI ¼b0þb1ER þb2GDP þb3OIL þb4DOL þl (1)
whe e CPI, ER, GDP, OIL and DOL ep esen he consume p ice index, nominal exchange a e, eal GDP,
oil p ice, and dolla iza ion, espec i ely. l signi ies he e o e m. Excep o dolla iza ion, we con e ed
all sc u inized a iables in o a na u al loga i hm, as shown in Eq. (2), o a oid he occu ence o he e o-
skedas ici y p oblems and o ease ou in e p e a ion in a pe cen age o m.
Table 1. Va iable desc ip ions and sou ces.
Va iable Symbol Uni o measu emen Sou ce
In la ion CPI Consume p ice index FSNAU
Nominal exchange a e ER Somali shilling pe 1 US dolla IMF
Real GDP GDP G oss domes ic p oduc (GDP) (cons an
2015 US$)
UNSD
Oil p ices OIL In e na ional B en c ude oil p ice in US
dolla pe ba el
FRED
Dolla iza ion DOL I is a dummy a iable. I akes a alue o
‘1’du ing he dolla iza ion pe iod, and
a alue o ‘0’o he wise.
6 A. H. ABDI ET AL.
lnCPI ¼b0þb1lnER þb2lnGDP þb3lnOIL þb4DOL þl (2)
3.3. Nonlinea au o eg essi e dis ibu ed lag (NARDL) model
The non-linea ARDL echnique p oposed by Shin e al. (2014) consis en ly cap u es he long- un and
sho - un non-linea i ies be ween a iables. This app oach is sui able o analyzing mac oeconomic and
inancial a iables a ec ed by un o eseen e en s. The NARDL coin eg a ion app oach ou pe o ms o he
adi ional coin eg a ion echniques because i es ima es a iables ega dless o whe he hey a e s a-
iona y a le el I(0), a i s di e ence I(1), o a mixed in eg a ion. Howe e , i is no sui able o highe
o de s o in eg a ion. Addi ionally, i is c edible and app op ia e o es ima e he asymme ic coin eg a-
ion o a small sample size. Besides his, ecen empi ical s udies indica ed ha u ilizing he linea ARDL
model canno bes explain he ela ionship be ween a iables wi h asymme ic associa ion in na u e.
The symme ic ARDL assumes ha he magni ude o exchange a e app ecia ion and dep ecia ion a ec
consume p ices equally. The ecen li e a u e con i med he p esence o asymme ic coin eg a ion
be ween exchange a e and in la ion (Baha umshah e al., 2017; da Sil a Co eay & Minellaz, 2010;
Dela e & L
opez-Villa icencio, 2012). The e o e, his s udy u ilizes he NARDL model o Shin e al. (2014)
o check he asymme ic ela ionship be ween exchange a es and in la ion by ollowing he p e ious
empi ical s udies o Balcila e al. (2019), Baha umshah e al. (2017), and Pa k and Son (2020). Thus, ou
NARDL model is speci ied unde he condi ional e sion as ollows:
DlnCPI ¼a0þb1lnCPI −1þbþ
2lnERþ
−1þb−
3lnER−
−1þb4lnGDP −1þb5lnOIL −1þb6DOL −1þX
p
i¼1
c1DlnCPI −i
þX
q
i¼1
cþ
2DlnERþ
−iþX
q
i¼1
c3DlnER−
−iþX
q
i¼1
c4DlnGDP −iþX
q
i¼1
c5DlnOIL −iþX
q
i¼1
c6DDOL −iþe
(3)
whe eas a
0
is he in e cep , cindica es he coe icien s o sho - un, b ep esen s he coe icien s o
long- un a iables, pand q ep esen he lag leng h, he symbol Ds ands o change, and i ep esen s
he lagged alues. The no a ions “−”and “þ”o he independen a iable o he exchange a e indica e
he decomposi ion o he pa ial sum o nega i e and posi i e exchange a e changes, espec i ely. This
is exp essed as ollows:
lnERþ
¼X
i¼1
DlnERþ
i¼X
i¼1
max DlnERi,0
ðÞ (4)
lnER−
¼X
i¼1
DlnER−
i¼X
i¼1
min DlnERi,0
ðÞ (5)
As o he checking o long- un asymme ic coin eg a ion, he Wald F- es is u ilized (Shin e al.,
2014). The hypo hesis is o mula ed as ollows: he null hypo hesis (H0:b0¼bþ
2¼b3¼0) sugges s ha
he impac o exchange a e on in la ion is linea (symme ic) in he long- un, whe eas he al e na i e
hypo hesis (Ha:b06¼ bþ
26¼ b36¼0) s a es ha he e ec is nonlinea (asymme ic) in he long- un. To
each a conclusion on he hypo hesis, he F-s a is ics is compa ed o c i ical alues. I he null hypo hesis
is disca ded, he p esence o an asymme ic ela ionship be ween he exchange a e and in la ion is
alid. Besides, we es ima e he sho - un cumula i e dynamic mul iplie e ec o a uni change in lnERþ
−1
and lnER−
−1using he ollowing o mula:
mþ
¼X
h
i¼0
@lnCPI þk
@lnERþ
−1
,m−
¼X
h
i¼0
@lnCPI þk
@lnER−
−1
,h¼0, 1, 2, ::: (6)
No e ha h !1,mþ
!bþ
2and m−
!b−
3:
COGENT ECONOMICS & FINANCE 7
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14 A. H. ABDI ET AL.
