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Is There Scope for Inflation Differentials in EMU? An Empirical Evaluation of the Balassa-Samuelson Model in EMU Countries

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Author Info
Alberola, Enrique
Tyrväinen, Timo

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Abstract

The Balassa-Samuelson (BS) model is evaluated in eight of the eleven EMU countries. This model suggests that productivity differentials between traded and non-traded goods sectors generate sectoral inflation differentials (dual inflation). Furthermore, differentials in the degree of dual inflation induce inflation differentials between countries. The standard BS model implies a cointegration relationship between relative prices and sectoral productivities. While this link generally seems to exist, the magnitudes of the parameter estimates are not in accordance with the theoretical model in most countries. As the presumed uniformity of sectoral wages is rejected in most cases, relative wages were allowed to enter the estimation. This extended BS model is endorsed by the data in every country. Simulations based on these results were carried out to quantify possible inflation differentials. Setting EMU-wide inflation equal to 2 per cent and assuming that PPP holds for traded goods, the projected inflation varies around the EMU-average within a margin of some +/-1 percentage points across the countries.

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File URL: http://www.bof.fi/NR/rdonlyres/C1D2653D-0F2B-4730-BB4D-24A8B0B08E21/0/DP_15_1998.pdf
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Paper provided by Bank of Finland in its series Research Discussion Papers with number 15/1998.

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Length: 46 pages
Date of creation: 20 Jul 1998
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Handle: RePEc:hhs:bofrdp:1998_015

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
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Related research
Keywords: sectoral productivity; inflation differentials; EMU;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Johansen, Soren, 1992. "Testing weak exogeneity and the order of cointegration in UK money demand data," Journal of Policy Modeling, Elsevier, vol. 14(3), pages 313-334, June. [Downloadable!] (restricted)
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  2. Gian Maria Milesi-Ferretti & S. Micossi, 1994. "Real Exchange Rates and the Prices of Nontradable Goods," IMF Working Papers 94/19, International Monetary Fund.
  3. Granger, Clive W J, 1986. "Developments in the Study of Cointegrated Economic Variables," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 48(3), pages 213-28, August.
  4. Dirk Pilat, 1996. "Labour Productivity Levels in OECD Countries: Estimates for Manufacturing and Selected Service Sectors," OECD Economics Department Working Papers 169, OECD, Economics Department. [Downloadable!]
  5. Jose De Gregorio & Holger C. Wolf & Alberto Giovannini, 1994. "International Evidence on Tradables and Nontradables Inflation," IMF Working Papers 94/33, International Monetary Fund.
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  6. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November. [Downloadable!] (restricted)
  7. Stephen Cecchetti & Nelson C. Mark & Robert Sonora, 1998. "Price Level Convergence among United States Cities: Lessons for the european central bank," Working Papers 32, Oesterreichische Nationalbank (Austrian Central Bank). [Downloadable!]
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  1. Diego Rodriguez Palenzuela & Gonzalo Camba-Mendez & Juan Angel Garcia, 2003. "Relevant economic issues concerning the optimal rate of inflation," Working Paper Series 278, European Central Bank. [Downloadable!]
  2. Lojschová, Adriana, 2003. "Estimating the Impact of the Balassa-Samuelson Effect in Transition Economies," Economics Series 140, Institute for Advanced Studies. [Downloadable!]
  3. Vladislav Flek & Lenka Markova & Jiri Podpiera, 2002. "Sectoral Productivity and Real Exchange Rate Appreciation: Much Ado about Nothing?," Working Papers 2002/04, Czech National Bank, Research Department. [Downloadable!]
  4. Kenny, Geoff & Meyler, Aidan & Quinn, Terry, 1998. "Bayesian VAR Models for Forecasting Irish Inflation," MPRA Paper 11360, University Library of Munich, Germany. [Downloadable!]
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  5. Ronald MacDonald, 2000. "The role of the exchange rate in economic growth: a euro-zone perspective," Research series 200005-5, National Bank of Belgium. [Downloadable!]
  6. Carla Massidda & Paolo Mattana, 2008. "Regional productivity and relative prices dynamics: the case of Italy," The Annals of Regional Science, Springer, vol. 42(4), pages 945-966, December. [Downloadable!] (restricted)
  7. Iika Korhonen & Mare Randveer, 2000. "Assessment of the Euro\'s implications for European economic development," Bank of Estonia Working Papers 2000-2, Bank of Estonia, revised 11 Oct 2000. [Downloadable!]
  8. Philipp Maier, 2004. "EMU enlargement, inflation and adjustment of tradable goods prices: What to expect?," DNB Working Papers 010, Netherlands Central Bank, Research Department. [Downloadable!]
  9. Michael Brandmeier, 2006. "Reasons for Real Appreciation in Central Europe," cege – Center for European, Governance and Economic Development Research Discussion Papers 55, cege – Center for European, Governance and Economic Development Research, University of Goettingen (Germany).. [Downloadable!]
  10. Quinn, Terry & Kenny, Geoff & Meyler, Aidan, 1999. "Inflation Analysis: An Overview," MPRA Paper 11361, University Library of Munich, Germany. [Downloadable!]
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