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Can Domestic Policies Influence Inflation?

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  • Ashoka Mody
  • Franziska Ohnsorge

Abstract

Globalization operates not only by reducing domestic pressures on inflation but also by reducing the scope of domestic authorities to influence the pace of inflation. First, as markets are integrated, the common, cross-border sources of inflation increase, reducing the extent of domestically-generated inflation. Based on a methodology identifying common time and sectoral trends, we find this to be especially the case in the countries of the eurozone, with their longer histories of product market integration. Second, even the domestically-generated component of inflation may be difficult to manipulate. Policies act, especially in the shortrun, through managing domestic demand. But the relationship between domestic demand (proxied by the output gap and unit labor cost growth) and inflation has been weak, constrained in part by trade openness. Moreover, the domestic component of inflation contains a country-specific international catch-up process that generates price equalization across countries. The evidence is that catch-up has accelerated with increasing market integration. Thus, for the eurozone economies, there may be limits on the use of fiscal and labor market policies to contain inflation. The new member states may not have policy leverage to meet the Maastricht inflation limit necessary for entering the eurozone. Casestudies show that fiscal consolidation needed to comply with the inflation criterion can be large and sustained only briefly to get under the Maastricht wire.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/257.

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Length: 36
Date of creation: 01 Nov 2007
Date of revision:
Handle: RePEc:imf:imfwpa:07/257

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Keywords: Markets; inflation; monetary policy; price level; inflation rates; inflation rate; monetary economics; relative price; inflation dynamics; money market; monetary fund; average inflation; central bank; real money; monetary union; actual inflation; low inflation; price inflation; rate of inflation; european monetary union; monetary policies; high inflation; wage inflation; inflationary pressure; inflation across countries; inflation convergence; rational expectations; inflation process; international monetary policy; restrictive monetary policy; price of goods; lower inflation; measure of inflation; optimal monetary policy; domestic monetary policy; annual inflation; real interest rates; reduction of inflation; tight monetary policy; inflation performance;

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Citations

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Cited by:
  1. Roman Horváth & Kamila Koprnická, 2008. "Inflation Differentials in EU New Member States: An Empirical Evidence," Working Papers IES, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies 2008/24, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Oct 2008.
  2. Eickmeier, Sandra & Moll, Katharina, 2009. "The global dimension of inflation - evidence from factor-augmented Phillips curves," Working Paper Series, European Central Bank 1011, European Central Bank.
  3. Emil Stavrev, 2009. "Forces Driving Inflation in the New EU10 Members," IMF Working Papers 09/51, International Monetary Fund.
  4. Alf Vanags & Morten Hansen, 2008. "Stagflation in Latvia: how long, how far, how deep?," Baltic Journal of Economics, Baltic International Centre for Economic Policy Studies, Baltic International Centre for Economic Policy Studies, vol. 8(1), pages 5-28, October.
  5. Dora M. Iakova, 2007. "Flattening of the Phillips Curve," IMF Working Papers 07/76, International Monetary Fund.
  6. Josef Baumgartner, 2008. "Statistical Decomposition of Product-Specific Inflation Rates in Austria," Austrian Economic Quarterly, WIFO, vol. 13(4), pages 156-170, December.
  7. César Calderón & Klaus Schmidt Hebbel, 2008. "What Drives Inflation in the World?," Working Papers Central Bank of Chile, Central Bank of Chile 491, Central Bank of Chile.
  8. Robert Anderton & Alessandro Galesi & Marco Lombardi & Filippo di Mauro, . "Key elements of global inflation," Discussion Papers 09/22, University of Nottingham, GEP.
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  10. Isabell Koske & Nigel Pain, 2008. "The Usefulness of Output Gaps for Policy Analysis," OECD Economics Department Working Papers 621, OECD Publishing.
  11. Siklos, Pierre L., 2010. "Meeting Maastricht: Nominal convergence of the new member states toward EMU," Economic Modelling, Elsevier, Elsevier, vol. 27(2), pages 507-515, March.
  12. Fröhling, Annette & Lommatzsch, Kirsten, 2011. "Output sensitivity of inflation in the euro area: Indirect evidence from disaggregated consumer prices," Discussion Paper Series 1: Economic Studies 2011,25, Deutsche Bundesbank, Research Centre.

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