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Exchange Rates, Nominal Inertia and Inflation
Author(s) -
Ireland Jonathan,
WrenLewis Simon
Publication year - 1998
Publication title -
scottish journal of political economy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.4
H-Index - 46
eISSN - 1467-9485
pISSN - 0036-9292
DOI - 10.1111/1467-9485.00110
Subject(s) - disinflation , economics , exchange rate , inflation (cosmology) , credibility , inertia , rational expectations , nominal interest rate , econometrics , wage , international fisher effect , macroeconomics , monetary economics , monetary policy , real interest rate , labour economics , physics , classical mechanics , theoretical physics , political science , law
This paper examines the use of the nominal exchange rate in achieving disinflation under managed exchange rate regimes. Most previous empirical studies have not explicitly identified expectations in the wage and price setting behaviour of their econometric models, despite the importance of expectations both during a disinflation and in correcting misalignments. This has meant that costs due to nominal inertia and non‐neutralities have not been addressed separately from questions of credibility. We present results for the UK economy using both a theoretical and empirical model in which firms and workers form rational expectations, but where there is also nominal inertia. We identify costs in using the exchange rate to change the inflation rate, and also the costs involved in correcting any disequilibria in the real exchange rate.