Gaining Policy Credibility in the EMS: The Case of Ireland

Abstract

This paper presents evidence that Ireland`s disinflation policy has derived credibility from its participation in the exchange rate mechanism of the EMS. Before 1979, Irish inflation expectations followed mainly the expected movements of prices in the United Kingdom. Given the accommodating stance of exchange rate policy in the latter country, the influence of changes in international price competitiveness on expected inflation in Ireland was minor. In contrast, upon entry into the EMS the Irish expectations soon converged toward the expected price behavior of partners in the exchange rate mechanism, and competitiveness became an important influence on expected inflation in Ireland. A loss of competitiveness at the beginning of the disinflation seems to have been instrumental in establishing its credibility.

JEL Classification: 311, 431