Non-Traded, Traded and Aggregate Inflation In Ireland (Part 2)

Abstract

This paper attempts to shed further light on the primary determinants of Irish inflation. By way of introduction, the paper provides a critical assessment of the Irish literature to date within the context of several key international theories. Several areas of controversy surface from this review: there exists little or no consensus regarding (a) the main causes of consumer price inflation in Ireland (b) the role of wages in the inflation process and (c) the role played by domestic factors in determining Irish inflation. The main body of the paper attempts to address each of these questions directly. It does so by formulating a model which tests for potentially divergent price determination in the traded and non-traded sectors of the economy. The analysis was facilitated by the construction of a new dataset which decomposed an underlying measure of consumer prices into its traded and non-traded components. For traded price inflation, the results suggest the strong role of the exchange rate and foreign inflation in conformity with the small open economy view. In the case of non-traded prices, the data rejected a strict version of the small open economy view. Nonetheless the strong role of the exchange rate and foreign prices was confirmed even for the non-traded sector. Furthermore, in the case of both traded and non-traded inflation, there was also significant evidence that real wage growth in excess of that which is warranted by productivity gains can lead to higher inflation. As would be expected, the results for aggregate inflation fall somewhere between those for its traded and non-traded components.