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Long-Run Determinants of Inflation Differentials in a Monetary Union

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  • Filippo Altissimo
  • Pierpaolo Benigno
  • Diego Rodriguez Palenzuela

Abstract

This paper analyzes the long-run determinants of inflation differentials in a monetary union. First, we aim at establishing some stylized facts relating the regional dispersion in headline inflation rates in the euro area as well as in the main components of the consumer price index. We find that a relatively large proportion of it occurs in the Service category of the EU's harmonized consumer price index (HICP). We then lay out a model of a monetary union with fully flexible prices, the long-run properties of which are analyzed. Our model departs in several respect from the Balassa-Samuelson hypotheses. Our results are in contrast with the result that movements in the real exchange rate are mainly driven by regionally asymmetric productivity shocks in the traded sectors. Our results point instead to relative variations in productivity in the non-traded sector as the primary cause of price and inflation differentials, with shocks to productivity in the traded sector being largely absorbed by movements in the terms of trade in the regional economies. These shocks are also found to largely drive the variability of real wages at the country level.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11473.

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Date of creation: Jul 2005
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Publication status: published as Altissimo, Filippo, Pierpaolo Benigno, and Diego Rodriguez Palenzuela. "Long-Run Determinants of Inflation Differentials in a Monetary Union." Moneda y Credito 220 (2005): 205-47.
Handle: RePEc:nbr:nberwo:11473

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  1. Smets, Frank & Wouters, Raf, 2002. "An estimated stochastic dynamic general equilibrium model of the euro area," Working Paper Series 0171, European Central Bank.
  2. Stockman, Alan C & Tesar, Linda L, 1995. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," American Economic Review, American Economic Association, vol. 85(1), pages 168-85, March.
  3. James H. Stock & Mark W. Watson, 1998. "Diffusion Indexes," NBER Working Papers 6702, National Bureau of Economic Research, Inc.
  4. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
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