Test of an Inverted J-Shape Hypothesis between the Expected Real Exchange Rate and Real Output: The Case of Ireland

Applying an open-economy macroeconomic model, incorporating the monetary policyreaction function and uncovering interest parity, this paper finds that the expected realexchange rate and real output exhibit an inverted J-shape relationship, suggesting thatexpected real depreciation increases real output during 1999.Q2-2001.Q3 whereas expectedreal appreciation raises output during 2001.Q4-2009.Q1. Other findings show that a higherreal financial stock price, a higher world real interest rate, or a lower expected inflationrate would increase real output. Fiscal prudence may be needed as the coefficient of thegovernment borrowing/GDP ratio is insignificant at the 10% level.