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Structural Model Of Irish Inflation

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  • Slevin, Geraldine

    (Central Bank and Financial Services Authority of Ireland)

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.

Suggested Citation

  • Slevin, Geraldine, 2003. "Structural Model Of Irish Inflation," Research Technical Papers 1/RT/03, Central Bank of Ireland.
    • Handle: RePEc:cbi:wpaper:1/rt/03
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    References listed on IDEAS

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    1. Johansen, Soren & Juselius, Katarina, 1990. "Maximum Likelihood Estimation and Inference on Cointegration--With Applications to the Demand for Money," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(2), pages 169-210, May.
    2. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
    3. Browne, F. X., 1984. "The international transmission of inflation to a small open economy under fixed exchange rates and highly interest-sensitive capital flows : An Empirical Analysis," European Economic Review, Elsevier, vol. 25(2), pages 187-212, July.
    4. 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.
    5. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-1580, November.
    6. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
    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.
    8. 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.
    9. 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).
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    Cited by:

    1. 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.
    2. Bermingham, Colin, 2005. "Employment and Inflation Responses to an Exchange Rate Shock in a Calibrated Model," Research Technical Papers 2/RT/05, Central Bank of Ireland.
    3. Bermingham, Colin, 2008. "Quantifying the Impact of Oil Prices on Inflation," Research Technical Papers 8/RT/08, Central Bank of Ireland.

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