Devaluation and Competitiveness in a Small Open Economy; Ireland 1987-1993

Abstract

This paper studies market expectations of a devaluation of the Irish pound from 1987 to 1993, and relates them to the evolution of Ireland's competitiveness over the same period. Much of the volatility of expectations of the currency's devaluation can be explained by developments outside Ireland, particularly by past and anticipated movements of sterling. The devaluation of the Irish pound in January 1993 is estimated to have exceeded investors' realignment expectations as well as the loss of Irish competitiveness since the beginning of the ERM crisis. This "excess devaluation" helps to explain subsequent large capital inflows and the pound's smooth transition to the wide ERM band in August 1993.