Working Paper: CEPR ID: DP5349
Authors: Patrick Honohan; Anthony J. Leddin
Abstract: Despite anchoring the Irish monetary system to a common zone-wide exchange rate and interest rate, EMU has triggered sizable 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 wouldhave counseled - 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 on the capacity of the labour market to absorb sizable 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.
Keywords: Asymmetric shocks; European Monetary Union; Ireland
JEL Codes: E32; E42; F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| EMU entry (F36) | increased scale and frequency of exogenous shocks (F65) |
| increased scale and frequency of exogenous shocks (F65) | property prices (R31) |
| increased scale and frequency of exogenous shocks (F65) | construction activity (L74) |
| fall in nominal interest rates (E43) | property prices (R31) |
| fall in nominal interest rates (E43) | construction activity (L74) |
| property prices (R31) | labor market dynamics (J29) |
| increased migration (F22) | dampened wage responses (J39) |
| increased migration (F22) | prolonged output and employment effects (E23) |