Academic journal article Journal of the Statistical and Social Inquiry Society of Ireland

Money Demand in Ireland, 1933-2012

Academic journal article Journal of the Statistical and Social Inquiry Society of Ireland

Money Demand in Ireland, 1933-2012

Article excerpt

1. INTRODUCTION

In this paper we study the long-run dynamics of money (as measured by M1 and M2), real GDP, consumer prices and interest rates in Ireland over the period 1933-2012. The purpose of the analysis is to see whether the behavior of these time series in this eighty-year period can be explained by standard money demand theory. Somewhat surprisingly, there appears to be no literature that studies these variables in Ireland over a similar extended sample period, despite the fact that such studies have been conducted on a number of other countries. (2) The paper thus adds to the literature on developments in the Irish economy from a long-run perspective.

Ireland experienced a number of monetary and economic regimes in this period. Economic growth in Ireland was weak in the 1930s, largely as a consequence of the Great Depression and the "Economic War" with the UK that started in 1932 and during which a policy of economic self-sufficiency based on industrialization through import-substitution was instituted. (3)

While the war ended in 1938, the import-subsitution policy was continued for many years both during and after the Second World War or "The Emergency" as it is called in Ireland. (4 5) Economic growth in this period was weak, mainly due to poor economic policies (O Grada 2008). The 1950s ended with a policy-shift towards outward-looking economic policies, including tariff reductions and reliance on foreign direct investment, that began with the Programme for Economic Expansion in 1959, and heralded a period of relatively strong economic growth in the 1960s and 1970s. In the early 1980s, however, growth fell sharply, partly reflecting disinflation policies in a number of countries.

Our sample includes the "Celtic Tiger" boom that started in the early 1990s when the economy grew at a rapid rate for a sustained period driven largely by exceptional export performance accompanied by moderate wage and price inflation and healthy public finances. In the early-2000s, however, the boom that had been underpinned by fundamentals became one sustained by a credit-fuelled construction bubble, which ultimately culminated in the financial crisis beginning in 2008.

This long sample spans several monetary regimes. Thus, at the time of independence in 1922, the monetary and financial system of Ireland was completely integrated with that of the United Kingdom. While there were no changes to the monetary arrangements at independence, they evolved gradually over time. In 1927 a Currency Commission was established and Irish coins were issued, followed by bank notes in 1928. The Central Bank of Ireland (CBI) was established in 1943, partially in response to the fact that after the start of the war, it became clear that Ireland could not expect to rely on the Bank of England to serve as its central bank.

The link to the UK monetary system remained extremely close with the Irish pound pegged at unity to Sterling until Ireland joined the European Monetary System (EMS) in 1979. This was a fixed but adjustable exchange rate system. The central rate of the Irish pound against the German Mark was realigned seven times by a total of 35.75% between September 1979 and January 1987. (6) The pound was subsequently devalued by a further 8% in January 1993. With the bands broadened to +/- 15% in the summer of 1993, the CBI then operated monetary policy with some discretion until it became a founding member of the Economic and Monetary Union in 1999.

To conduct the study, we construct a long historical data set, drawing from a number of different secondary sources. The combination of data in this way is problematic. First, economic and statistical changes may make data lack comparability over time. For instance, the increase in the relative importance of services in the economy has arguably reduced the volatility of consumer prices. This process is likely to have been accentuated by the increase in the number of components in the CPI, which would have tended to reduce the volatility of the aggregate. …

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