DP4583 Exchange Rates and Inflation Under EMU: An Update
|Author(s):||Patrick Honohan, Philip R. Lane|
|Publication Date:||August 2004|
|Keyword(s):||EMU, exchange rates, inflation|
|JEL(s):||E31, E42, F41|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=4583|
In our recent Economic Policy article (Honohan and Lane, 2003), we argued that the strength of the US dollar 1999-2001 had an important impact on inflation divergence within the EMU and in particular the surge in Ireland?s inflation to over 7%. This hypothesis has been subjected to a grueling out-of-sample test: would the dollar?s subsequent weakness contribute to inflation convergence and in particular to a fall in Irish inflation? Fortunately for us, the theory has passed the test with flying colours. Irish inflation stopped dead in its tracks: consumer prices were unchanged between May and November of 2003. Regression analysis on quarterly inflation data across EMU members 1999.1-2004.1 confirms the importance of the exchange rate channel, although pinning down the exact dynamic specification will require a further span of data.