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Exchange Rates and Inflation under EMU: An Update

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  • Philip Lane
  • Patrick Honohan

Abstract

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 per cent. 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.

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Paper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp031.

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Date of creation: 28 Jan 2005
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Handle: RePEc:iis:dispap:iiisdp031

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  1. Angeloni Ignazio & Ehrmann Michael, 2007. "Euro Area Inflation Differentials," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-36, August.
  2. Patrick Honohan & Philip R. Lane, 2003. "Divergent inflation rates in EMU," Economic Policy, CEPR & CES & MSH, vol. 18(37), pages 357-394, October.
  3. Papell, David H., 2006. "The Panel Purchasing Power Parity Puzzle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(2), pages 447-467, March.
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