Explaining Irish Inflation During the Financial Crisis
AbstractThe recent financial crisis resulted in a steep contraction in the domestic economy together with a sharp decline in inflation. The Phillips curve model of inflation argues that inflation should be negatively related to economic performance and this would seem to be a potential explanatory factor in the behaviour of Irish inflation during the financial crisis. However, Ireland is a very open economy and the Phillips curve has been criticised as an inappro- priate model of inflation for Ireland on the basis that inflation is primarily imported from abroad with little role for domestic factors. We formally assess what role domestic economic activity has on inflation in Ireland. We make a number of findings. First, the deflation in Ireland was unusual by domestic historical and international standards. Second, we find the short-run unemployment gap is the most appropriate way to measure slack in the domestic economy. Third, having controlled for international factors, there is a relationship between the domestic economy and inflation. Fourth, the relationship is not stable over time but seems to depend on the state of the business cycle. Fifth, these types of models predict the actual fall in inflation during the financial crisis quite well. We conclude that these results support the idea that inflation is not purely externally determined in Ireland.
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Bibliographic InfoPaper provided by Central Bank of Ireland in its series Research Technical Papers with number 09/RT/12.
Date of creation: Dec 2012
Date of revision:
Phillips Curve; Financial Crisis; Threshold Model;
Other versions of this item:
- Bermingham, Colin & Coates, Dermot & Larkin, John & O'Brien, Derry & O'Reilly, Gerard, 2012. "Explaining Irish Inflation during the Financial Crisis," Economic Letters 13/EL/12, Central Bank of Ireland.
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-01-12 (All new papers)
- NEP-MAC-2013-01-12 (Macroeconomics)
- NEP-MON-2013-01-12 (Monetary Economics)
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