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Structural Model Of Irish Inflation

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  • Slevin, Geraldine

    (Central Bank and Financial Services Authority of Ireland)

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    Abstract

    This paper attempts to shed some light on the primary determinants of Irish inflation. The paper begins by providing a review of the Irish literature to date. This suggests that there is little agreement on the main causes of inflation in Ireland. This paper attempts to address this issue directly. This is achieved by formulating a model for both the traded and non-traded sectors of the economy. Consumer prices were thus decomposed into their traded and non-traded components. The traded sector tests the small open economy assumption whereby traded prices are determined by foreign prices and the exchange rate in the long-run. Absolute purchasing power parity (PPP) states that the price of a basket of goods in one country will equal the price of the same basket of goods in a foreign country converted at the relevant nominal effective exchange rate. This assumption was not rejected by the data and a strong relationship was found to exist. The non-traded sector examines the domestic causative factors affecting inflation whereby non-traded inflation is modelled as arising from a mark-up behaviour over wages adjusted for productivity. In this case the Balassa-Samuelson effect was evident as higher demand in the non-traded sector led to increased wages. Wage/price equality was not rejected by the data. The results for the traded sector demonstrated that a half life of deviations away from equilibrium would take approximately 14 quarters. The corresponding adjustment in the non-traded sector would take approximately 4 quarters. Both models were used for forecasting purposes and were found to provide reasonable and accurate forecasts.

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    Bibliographic Info

    Paper provided by Central Bank of Ireland in its series Research Technical Papers with number 1/RT/03.

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    Length: 38 pages
    Date of creation: Jun 2003
    Date of revision:
    Handle: RePEc:cbi:wpaper:1/rt/03

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    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Kenny, Geoff & McGettigan, Donal, 1996. "Non-Traded, Traded and Aggregate Inflation In Ireland (Part 2)," Research Technical Papers 3B/RT/96, Central Bank of Ireland.
    2. Callan, Tim & FitzGerald, John, 1989. "Price Determination in Ireland: Effects of Changes in Exchange Rates and Exchange Rate Regimes," Papers ME179, Economic and Social Research Institute (ESRI).
    3. Johansen, Soren & Juselius, Katarina, 1994. "Identification of the long-run and the short-run structure an application to the ISLM model," Journal of Econometrics, Elsevier, vol. 63(1), pages 7-36, July.
    4. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
    5. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
    6. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
    7. Johansen, Søren & Juselius, Katarina, 1992. "Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK," Journal of Econometrics, Elsevier, vol. 53(1-3), pages 211-244.
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    Cited by:
    1. Bermingham, Colin, 2008. "Quantifying the Impact of Oil Prices on Inflation," Research Technical Papers 8/RT/08, Central Bank of Ireland.
    2. Colin Bermingham, 2006. "Employment and Inflation Responses to an Exchange Rate Shock in a Calibrated Model," The Economic and Social Review, Economic and Social Studies, vol. 37(1), pages 27-46.

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