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A Mechanism of Inflation Differentials and Current Account Imbalances in the Euro Area

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  • Harashima, Taiji

Abstract

This paper examines the mechanism of persistent inflation differentials, current account imbalances, and fiscal deficits in the euro area by constructing a multi-country model in which the optimization behaviors of governments as well as those of households, firms, and the European Central Bank are explicitly incorporated. The model indicates that governments can temporarily adhere to their own intrinsic preferences because fiscal policies are not unified in the euro area. This behavior generates problems, such as inflation differentials, and the stability and growth pact does not appear to be sufficiently effective in preventing such deviations. The results in this paper imply that the balance between national sovereignty and economic stability should be shifted more to the side of stability and that the euro area has to become more politically unified. In addition, the inflation differentials provide clear evidence that inflation acceleration is not caused by monetary policies but by government behavior because monetary policies are unified in the euro area whereas fiscal policies are not.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 28121.

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Date of creation: 18 Jan 2011
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Handle: RePEc:pra:mprapa:28121

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Keywords: The euro; Monetary union; Inflation; Inflation differential; Current account imbalance; Fiscal deficit; Time preference; The European Central Bank; The stability and growth pact;

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Cited by:
  1. Nicola Acocella, . "A tale of two cities: exit policies in Washington and Frankfurt," Working Papers 117/13, Sapienza University of Rome, Metodi e modelli per l'economia, il territorio e la finanza MEMOTEF.

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