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Inflation Differentials in the Euro Area and their Determinants – an empirical view

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  • Juan Ignacio Aldasoro
  • Václav Žďárek

Abstract

In this paper, we present evidence on the statistical features of observed dispersion in HICP inflation rates in the Euro area. Our descriptive exercise shows that there is still a remarkable dispersion of HICP inflation rates across the member countries. We find that most of dispersion originates in the non-traded categories of the HICP. This suggests that the main source of dispersion in countries' headline inflation rates is in those components of the HICP where non-traded goods (services, (public) goods with regulated and administered prices) are more intensely represented. We then examine the determinants of inflation differentials in a panel of the states of the Euro area in 1999–2007 using alternative classifications of this group and three different datasets. The evidence presented shows that output gaps and a proxy for price level convergence were statistically significant. On the other hand, some determinants that were found significant in previous studies (for example Honohan and Lane, 2003, 2004; ECB, 2003) has no impact on inflation in our expanded time span (e.g. exchange rate movements) The dispersion of HICP inflation is expected to increase in the coming years as the new EU member states will join the Euro area. There are some risks for these countries connected with the common monetary policy, which is adjusted more to the conditions of stabilized advanced economies forming the core of the Euro area. This creates potential problems for the EU common monetary policy (ECB), in particular negative (positive) interest rates, their repercussions on investment processes, consumption and the possibility of creating asset bubbles.

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Bibliographic Info

Paper provided by William Davidson Institute at the University of Michigan in its series William Davidson Institute Working Papers Series with number wp958.

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Length: pages
Date of creation: 01 Apr 2009
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Handle: RePEc:wdi:papers:2009-958

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Keywords: inflation differentials; price convergence; exchange rate; panel data;

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  1. Maurice Obstfeld, 1999. "EMU: Ready, or Not?," NBER Working Papers 6682, National Bureau of Economic Research, Inc.
  2. Michael Reutter & Hans-Werner Sinn, 2000. "The Minimum Inflation Rate for Euroland," CESifo Working Paper Series 377, CESifo Group Munich.
  3. Maurice Obstfeld, 1997. "Europe's gamble," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(2), pages 241-317.
  4. John Lewis, 2007. "Hitting and Hoping? Meeting the Exchange Rate and Inflation Criteria during a Period of Nominal Convergence," CESifo Working Paper Series 1902, CESifo Group Munich.
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