The international transmission of inflation to a small open economy under fixed exchange rates and highly interest-sensitive capital flows: An Empirical Analysis

Abstract

This paper deals with the international transmission of inflation to a small open economy (SOE) under fixed exchange rates and facing very interest sensitive capital flows. It focuses particular attention on a channel of transmission which has been hitherto largely ignored, namely portfolio capital flows arising from the monetary policy actions of the SOE's reserve currency country (RCC). The bulk of the existing literature on this topic regards portfolio capital flows, and money in general, as having no causative role but simply passively mirroring transmission through commodity markets. The model obtains strong support for Ireland from 1972 to 1979 during which the IR£ was maintained in a strict one-for-one parity with the £stg.