International price transmission in CGE models: How to reconcile econometric evidence and endogenous model response?

The importance of empirically analyzing the transmission of international prices to and their impacts on domestic markets is growing particularly since the 2006–2008 food price hikes. However, the field is dominated by econometric Price Transmission Analysis (PTA) but surprisingly disconnected from analyses based on simulation models such as Computable General Equilibrium (CGE) models. The missing reconciliation among these tools could be due to PTA often being concerned with high frequency data and short-term adjustment processes, which does not reconcile well with the annual data of CGE analyses; different research teams in econometric time series analysis and CGE modeling with typically little overlap; and the endogeneity of price transmission in CGE models. Due to this endogeneity, the calibration of CGE models to empirically observed price transmission is not straightforward, as an infinite combination of model parameters and specifications allows for reaching a certain level of price transmission. This paper aims at paving the way for the integrated use of PTA and CGE models by analyzing how a given degree of price transmission from the international to the domestic market, which may be determined empirically e.g. based on a vector error correction model, can be met in a single country CGE model. We examine and validate seven hypothetical determinants including structural characteristics of the model, the parameterization of behavioral functions and properties of the sectors concerned. The findings of this paper support controlling the pass-through of prices from the international to the domestic market in CGE models.