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European Journal of Economics, Finance and Administrative Sciences ISSN 1450-2887 Issue 18 (2010) © EuroJournals, Inc. 2010 http://www.eurojournals.com

The Relationship between Inflation and Real Exchange Rate: Comparative Study between ASEAN+3, the EU and North America

Noer Azam Achsani Department of Economics and International Centre for Applied Finance and Economics Bogor Agricultural University, Indonesia E-mail: achsani@yahoo.com (preferred) or achsani@mb.ipb.ac.id Tel. +62-251-8377662; Fax. +62-251-8377896

Arie Jayanthy F A Fauzi Graduate School of Management and Business, Bogor Agricultural University, Indonesia E-mail: ariesangputriraja@yahoo.com Tel: +62-251-8313813; Fax: +62-251-8318515

Piter Abdullah Center for Central Banking Research, Bank Indonesia E-mail: piter@bi.go.id

Abstract Inflation has always been one of the most important macroeconomic issues. Due to this importance, a study concerning the factors associated with the behavior of inflation needs to be done. This paper will be devoted to analyze the relevance of inflation with the exchange rates. The research will try to compare the response or sensitivity of inflation to the changes in real exchange rates in Asia (ASEAN +3) and compare the result with those of the EU and North America.

Using explorative statistical analysis and Granger-causality test, we found that there is a strong correlation between the movements of inflation with real exchange rate in most countries to be analyzed. For Asia, there is a significant one-way causal relationship, where the nominal and real exchange rates have a significant impact on the rate of inflation. On the other hand, in the Non-Asian regions, the causal relationship seems to be in the opposite direction. Furthermore, using panel data model with fixed effects, we found that the response or sensitivity of inflation to the changes in exchange rates in Asia is higher in compare to those in the EU and North America.

Keywords: Inflation, exchange rates, panel data JEL Classification Codes: C23, E31, E52

1. Introduction Basic macroeconomic indicators can be used as an illustration of a country's economic condition. One of the basic macroeconomic indicators is inflation. Generally, the inflation rate is used to measure the

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