The main purpose of this study is to examine the effects of the exchange rates,
international prices, and the demand shocks on inflation in Fiji Island . The study covers the
annual data from 1975 to 2010.The variables are transformed into changes/per cent and
then Ordinary Least Squares methodology (OLS) is used. The appropriateness of the OLS
assumptions is tested including the normality of the residuals, autocorrelations ,
heteroskedasticity and functional forms. The main findings are that the Fijian dollar depreciation
increases, the international price shocks in the form of Australian consumer prices increase,
the Keynesian demand shocks increase, and the devaluation events increase the consumer
price inflation in Fiji. As a monetary policy instrument the flexibility of the exchange rate policy
is indispensable for Fiji to absorb appropriately the international supply and price shocks.
We have been able to include the international supply shocks, the domestic demand shocks,
the exchange rates, and devaluation dummies in our model. Though we have used a simple
OLS model, the originality of our study is the comprehensiveness of the theoretical variables
in our model. This study will have an important implication for the small open economy of Fiji
especially its exchange rate policy.
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