Exchange rates and import prices for a small open economy: the case of Ireland

As a further contribution to the growing international literature on exchange rate pass-through (PT), this study assesses the extent of PT for Irish import prices over the period 1963 to 1995. It fills two important gaps in the literature, by making due allowance for the time series properties of the data and by concentrating on the case of a small open economy. In order to assess the extent of PT a mark-up model for aggregate import unit values is employed. It is argued that the usual single equation mark-up estimation technique leads to seriously biased and inefficient estimates of the degree of PT, as it ignores the strong simultaneity of import prices and domestic competing prices. This study makes use of the Johansen technique to allow for such simultaneity and uncovers two long-run equilibrium relationships among the data, for import unit values and domestic competing prices, and confirms the existence of very close to full PT for both. Previous results in the literature demonstrating substantially less than full PT may be due to the failure to make proper allowance for the time series properties of the data or for the strong simultaneity which exists between import and domestic competing prices.