Does the exchange rate regime affect the unemployment rate?

This chapter examines the implications of the exchange rate regime for unemployment. It provides empirical evidence for Ireland, using two macroeconometric models, HERMES-IRELAND and MULTIMOD, on how its membership in different exchange rate regimes can mediate the impact of external and domestic shocks on output and unemployment. Regarding the determinants of equilibrium unemployment, most labour market models agree that all factors which induce wage pressure on the part of workers and price pressures on the part of firms adversely affect the level of equilibrium employment. The chapter shows how the exchange rate regime modifies the impact of the expansion in German government expenditure on Irish output and unemployment. An expansion in German government expenditure increases interest rates in Germany due to the expansion in absorption. The flexible exchange rate regime insulates UK interest rates from the disturbance in Germany. The combination of the expansion in German demand and the depreciation of sterling increases economic activity and employment.