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Market structure and inflation differentials in the European Monetary Union

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  • Javier Andrés

    ()
    (Banco de España)

  • Eva Ortega

    ()
    (Banco de España)

  • Javier Vallés

    ()
    (Banco de España)

Abstract

In a monetary union, inflation rate differentials may be substantial over the business cycle. This paper parameterizes a two-country monetary union in which different economic structures in the two countries generate temporary inflation differentials. Cross-country differences are introduced in (i) the elasticity of demand in the goods markets, which cause producers to discriminate prices, (ii) the degree price inertia and (iii) openness or preference for foreign goods in consumption. The model is calibrated to reproduce two average big EMU countries and it is able to generate sizeable inflation differentials. We find the mechanism of price discrimination quantitatively more important than the differences in price inertia. Moreover, under asymmetric shocks, differences in the degree of openness as the ones observed within the EMU can have sizeable effects on the dispersion of inflation rates.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/03/Fic/dt0301e.pdf
File Function: First version, February 2003
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Bibliographic Info

Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 0301.

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Length: 43 pages
Date of creation: Feb 2003
Date of revision:
Handle: RePEc:bde:wpaper:0301

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  1. Pierpaolo Benigno & David López-Salido, 2002. "Inflation persistence and optimal monetary policy in the euro area," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 749, Board of Governors of the Federal Reserve System (U.S.).
  2. Goldberg, Pinelopi K. & Verboven, Frank, 2005. "Market integration and convergence to the Law of One Price: evidence from the European car market," Journal of International Economics, Elsevier, Elsevier, vol. 65(1), pages 49-73, January.
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  8. Margarida Duarte & Alexander L. Wolman, 2002. "Regional inflation in a currency union: fiscal policy vs. fundamentals," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 746, Board of Governors of the Federal Reserve System (U.S.).
  9. Martin, Christopher, 1993. "Price adjustment and market structure," Economics Letters, Elsevier, Elsevier, vol. 41(2), pages 139-143.
  10. Peersman, Gert & Smets, Frank, 2001. "The monetary transmission mechanism in the euro area: more evidence from VAR analysis," Working Paper Series, European Central Bank 0091, European Central Bank.
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  12. Stephen Cecchetti & Nelson C. Mark & Robert Sonora, 1998. "Price Level Convergence Among United States Cities: Lessons for the European Central Bank," Working Papers, Oesterreichische Nationalbank (Austrian Central Bank) 32, Oesterreichische Nationalbank (Austrian Central Bank).
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  14. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  15. Jordi Gali & Tommaso Monacelli, 1999. "Optimal Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Boston College Working Papers in Economics, Boston College Department of Economics 438, Boston College Department of Economics, revised 15 Nov 1999.
  16. Bela Balassa, 1964. "The Purchasing-Power Parity Doctrine: A Reappraisal," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 72, pages 584.
  17. Eva Ortega, 2003. "Persistent inflation differentials in Europe," Banco de Espa�a Working Papers, Banco de Espa�a 0305, Banco de Espa�a.
  18. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
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Citations

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Cited by:
  1. Ángel de la Fuente & Juan F. Jimeno, 2005. "The private and fiscal returns to schooling and the effect of public policies on private incentives to invest in education: a general framework and some results for the EU," Banco de Espa�a Working Papers, Banco de Espa�a 0509, Banco de Espa�a.
  2. Cavallero, Alessandro, 2011. "The convergence of inflation rates in the EU-12 area: A distribution dynamics approach," Journal of Macroeconomics, Elsevier, Elsevier, vol. 33(2), pages 341-357, June.
  3. Angeloni, Ignazio & Ehrmann, Michael, 2004. "Euro area inflation differentials," Working Paper Series, European Central Bank 0388, European Central Bank.
  4. Jane Ihrig & Steven B. Kamin & Deborah Lindner & Jaime Marquez, 2007. "Some simple tests of the globalization and inflation hypothesis," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 891, Board of Governors of the Federal Reserve System (U.S.).
  5. Adolfson, Malin & Laséen, Stefan & Lindé, Jesper & Villani, Mattias, 2005. "Bayesian Estimation of an Open Economy DSGE Model with Incomplete Pass-Through," Working Paper Series 179, Sveriges Riksbank (Central Bank of Sweden).
  6. Oliver Grimm & Stefan Ried, 2007. "Macroeconomic Policy in a Heterogeneous Monetary Union," SFB 649 Discussion Papers SFB649DP2007-028, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  7. Campolmi, Alessia & Faia, Ester, 2006. "Cyclical inflation divergence and different labor market institutions in the EMU," Working Paper Series, European Central Bank 0619, European Central Bank.

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