keeping the exchange rate from dropping to its ‘true’ value. This turned into a selffulfilling prophecy, and the actual rate consequently dropped to excessively low levels, reaching a low of 14 ZMW/USD on November 10.

- _Delayed policy response:_ The central bank remained passive in terms of monetary policy at first; at least in part because of the factors described above, the developments only took up more pace instead of settling. When authorities substantially tightened monetary policy in mid-November, the exchange rate rapidly stabilized, as did inflation.

The fact that consumer price inflation so markedly increased in line with the exchange rate depreciation during this episode may seem at odds with the finding of a relatively low overall exchange rate pass-through.<sup>5</sup> It is also not the case that the exchange rate fluctuations were driven by monetary shocks, which, based on our results, would explain part of the higher passthrough. We conjecture that this is related to the following factors:

- _Confounding factors:_ The currency crisis coincided with poor harvests in the agricultural sector, independently driving food price increases.

- _Size non-linearities:_ It is often conjectured that small changes in the exchange rate may translate into prices differently than large changes in the exchange rate (e.g., Aron et al., 2014), for several reasons. First, menu costs may imply that producers and retailers absorb small changes in the exchange rate through their profit margins, and will only adjust prices once a certain threshold has been surpassed. A large depreciation such as in late 2015 would then surpass these thresholds across sectors and firms, leading to a larger ERPT. Similarly, in times of large exchange rate fluctuations, retailers pay increased attention to the exchange rate and may adjust prices at a higher frequency. Anecdotal evidence suggests that this was the case during 2015, with some retailers informally declaring prices in USD, and converting them into kwachas based on the daily exchange rate for every purchase. This practice mechanically leads to a complete ERPT for these transactions.

# _7. Conclusions_

We investigated the dynamics of the exchange rate and its interaction with consumer prices in Zambia in a structural VAR framework, identifying shocks with a combination of theoretically plausible zero-restrictions and sign-restrictions. Crucially, we imposed minimal restrictions on the interaction between these two key variables. Furthermore, we explored the possibility of differential pass-through depending on which shock originally caused the exchange rate to fluctuate, and disaggregated these results into food and non-food items. Finally, we used our results and qualitative evidence to put into context the tumultuous period of late 2015.

Our findings suggest that the pass-through from the exchange rate to consumer prices is relatively moderate for genuine exchange rate shocks; we estimate a 10% depreciation to induce

> 5 To obtain an order of magnitude, a back of the envelope calculation using monthly exchange rates and price data between August and November 2015 data would suggest that a 60% depreciation came with an approximate 20% of additional inflation (when adjusting for a baseline inflation of about 7%), implying an ERPT of more than 30% in the short run. This is in contrast to about 7% suggested by our estimates.

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