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I´m trying to find siutable econometrics model for explaining inflation during financial crisis and after. My final model shows that if NEERnominal effective exchange rate) increases, the inflation increases too.

NEER is undertaken from Eurostat when increase of NEER means appreciation.

I´m not sure if this means increase above 100-> appreciaton. Or if any increase (for example from 78 to 80) means appreciaton.

I don´t know how to explain this model. Do anybody have any idea how the NEER works and why there is positive relationship between NEER and Inflation?

Thanks for any advice.

Here are my quarterly data for NEER: eurostat

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  • $\begingroup$ Do you know what the "Index, 2010 = 100$ button in the top left corner of the Eurostat site means? $\endgroup$
    – Giskard
    Commented Apr 27, 2018 at 9:23
  • $\begingroup$ I´m quite confused by this indices and labels of statistics databases. So does that mean that increase above 100 sign appreciaton or am I totally wrong ? $\endgroup$
    – EconLena
    Commented Apr 27, 2018 at 9:43

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An increase in the index from one point in time to a later point indicates a nominal appreciation over that period

Standard economic theory might suggest that would lead to lower prices than without such an appreciation, since imports would be cheaper and demand for exports could reduce

The Czech Krona was devalued at the end of 2013. An article published a year later by the Czech National Bank suggests it thought it achieved the aims, saying

Without having depreciated the exchange rate, deflation would have been significant, at least -1%, meaning that the Czech economy would already have entered deflation for an extended period. However, thanks to the exchange rate depreciation, the threat of deflation caused by a lack of demand and a downturn in the economy passed. Despite a significantly greater anti-inflationary effect abroad than was expected at the end of 2013, core inflation returned to positive values after nearly five years.

and this is consistent with standard economic theory

But if you want a rationalisation of why a currency appreciation may not have happened during a financial crisis, try thinking of a world where interest rates are tumbling worldwide and where carry-trade investors looking for nominal yield invest in countries where nominal interest rates are higher, possibly caused by higher inflation. Such a country might see higher inflation than other countries and at the same time an appreciating currency. The appreciating currency may then attract momentum investors, with the flood of money pushing interest rates lower than would be suitable to control inflation (especially if the country wanted to keep its exchange rates more stable), and the combination of more money and reducing interest rates could lead to higher inflation

To a small degree this may be what has happened in the Czech Republic more recently: it had slightly positive interest rates (until summer 2017, when they started to be increased) while the Euro area has had zero or negative short-term interest rates, and has seen an appreciation in the Krona against the Euro. There could be other explanations

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  • $\begingroup$ Thank you for your answer, I appreciate it. I understand the mechanism, that you´ve described, but it is possible to use this explanation even if the difference in nominal central bank interest rate was cca 0,5 percentage point? (this comparison includes interest rates of czech republic and eurozone). $\endgroup$
    – EconLena
    Commented Apr 28, 2018 at 6:07
  • $\begingroup$ My problem is, that domestic currency was devaluated from 2013 (to half of 2017) in Czech republic as an effort to increase an inflation. So my expectation was that NEER and inflation will be negatively correlated. My question now is that when I will use your explanation of positive relationship (between NEER and inflation) only on the period of financial crisis. Can I somehow explain the period from 2013 where both NEER and inflation decreased (still positive relationship in opposite direction) ? $\endgroup$
    – EconLena
    Commented Apr 28, 2018 at 6:08
  • $\begingroup$ @EconLena I have added something about the Czech position. The 2013 devaluation may have been associated with low inflation, but prices might have fallen without it $\endgroup$
    – Henry
    Commented Apr 28, 2018 at 8:53

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