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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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  • Alberola, Enrique
  • Tyrväinen, Timo

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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Bibliographic Info

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
Date of revision:
Handle: RePEc:hhs:bofrdp:1998_015

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Keywords: sectoral productivity; inflation differentials; EMU;

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References

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  1. Mark, Nelson C. & Sonora, Robert & Cecchetti, Stephen, 1998. "Price Level Convergence Among United States Cities: Lessons for the European Central Bank," Working Papers 32, Oesterreichische Nationalbank (Austrian Central Bank).
  2. 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.
  3. S. Micossi & Gian-Maria Milesi-Ferretti, 1994. "Real Exchange Rates and the Prices of Nontradable Goods," IMF Working Papers 94/19, International Monetary Fund.
  4. Jose De Gregorio & Alberto Giovannini, 1993. "International Evidence on Tradables and Nontradable Inflation," NBER Working Papers 4438, National Bureau of Economic Research, Inc.
  5. Johansen, Soren & Juselius, Katarina, 1994. "Identification of the long-run and the short-run structure an application to the ISLM model," Journal of Econometrics, Elsevier, vol. 63(1), pages 7-36, July.
  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.
  7. Cumby, Robert & Diba, Behzad & Canzoneri, Matthew & Eudey, Gwen, 1998. "Trends in European Productivity: Implications for Real Exchange Rates, Real Interest Rates and Inflation Differentials," Working Papers 27, Oesterreichische Nationalbank (Austrian Central Bank).
  8. Dirk Pilat, 1996. "Labour Productivity Levels in OECD Countries: Estimates for Manufacturing and Selected Service Sectors," OECD Economics Department Working Papers 169, OECD Publishing.
  9. 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.
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Citations

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Cited by:
  1. 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.
  2. Quinn, Terry & Kenny, Geoff & Meyler, Aidan, 1999. "Inflation Analysis: An Overview," Research Technical Papers 1/RT/99, Central Bank of Ireland.
  3. Rodriguez-Palenzuela, Diego & Camba-Méndez, Gonzalo & García, Juan Angel, 2003. "Relevant economic issues concerning the optimal rate of inflation," Working Paper Series 0278, European Central Bank.
  4. João Rebelo Barbosa & Rui Henrique Alves, 2011. "Divergent competitiveness in the eurozone and the optimum currency area theory," FEP Working Papers 436, Universidade do Porto, Faculdade de Economia do Porto.
  5. Nikolay Nenovsky & Kalin Hristov, 2001. "Official Eurozation of Bulgaria: Pluses and Minuses," Economic Studies journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 1, pages 64-80.
  6. João Rebelo Barbosa & Rui Henrique Alves, 2011. "The Euro Area Ten Years after Its Creation: (Divergent) Competitiveness and the Optimum Currency Area Theory," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 58(5), pages 605-629, December.
  7. Philipp Maier, 2004. "EMU enlargement, inflation and adjustment of tradable goods prices: What to expect?," DNB Working Papers 010, Netherlands Central Bank, Research Department.
  8. Issing, Otmar, 2001. "The Single Monetary Policy of the European Central Bank: One Size Fits All," International Finance, Wiley Blackwell, vol. 4(3), pages 441-62, Winter.
  9. Kenny, Geoff & Meyler, Aidan & Quinn, Terry, 1998. "Bayesian Var Models for Forecasting Irish Inflation," Research Technical Papers 4/RT/98, Central Bank of Ireland.
  10. 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.
  11. Brandmeier, Michael, 2006. "Reasons for real appreciation in Central Europe," Center for European, Governance and Economic Development Research Discussion Papers 55, University of Goettingen, Department of Economics.

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