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Ireland in EMU - More Shocks, Less Insulation?

  • Patrick Honohan

    (The World Bank and CEPR)

  • Anthony J. Leddin

    (University of Limerick)

Despite anchoring the Irish monetary system to a common zone-wide exchange rate and interest rate, EMU has triggered sizeable exchange rate and especially interest rate shocks to the Irish economy (albeit not appreciably greater than those experienced under previous exchange rate regimes). Interest rate movements have deviated widely from what a standard Taylor monetary policy rule would have counselled – though here again the deviations have been no worse in this regard than those of the previous regime. The most important shock has been associated with the large and sustained initial fall in nominal interest rates as EMU began. Through mechanisms which we formally model, the interest rate fall has had a lasting effect on property prices, construction activity and the capacity of the labour market to absorb sizeable net immigration, despite a sharp deterioration in wage competitiveness since 2002. As the long drawn-out impact of this shock subsides, the failure of the wage-bargaining system promptly to claw back the loss of competitiveness resulting from exogenous exchange rate movements is increasingly likely to show up in weaker aggregate employment performance.

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Article provided by Economic and Social Studies in its journal Economic and Social Review.

Volume (Year): 37 (2006)
Issue (Month): 2 ()
Pages: 263-294

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Handle: RePEc:eso:journl:v:37:y:2006:i:2:p:263-294
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