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Exchange Rates and Inflation under EMU: An Update

  • Philip Lane
  • Patrick Honohan

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, 2004. "Euro area inflation differentials," Working Paper Series 0388, European Central Bank.
  2. 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.
  3. Philip R. Lane & Patrick Honohan, 2003. "Divergent Inflation Rates in EMU," Trinity Economics Papers 20034, Trinity College Dublin, Department of Economics.
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