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Macroeconomic implications of low inflation in the euro area

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  • von Hagen, Jürgen
  • Hofmann, Boris

Abstract

The ECB’s official inflation objective is an increase in the Harmonised Index of Consumer Prices of below 2% in the medium run. Many commentators argue that there is a deflationary bias in this definition because the lower bound of the inflation objective is not clearly specified. It is also often claimed that the ECB’s ambitious inflation objective increases the risk of a liquidity trap and may give rise to higher long-term unemployment because of rigid labour markets in the euro area. An assessment of the experience with the ECB’s inflation objective over the first four years of EMU reveals that the discussion about the lower bound of the ECB’s inflation objective is essentially pointless, because headline inflation was barely below two percent. Fears of a liquidity trap or higher unemployment also appear not to be supported by the empirical evidence. Another popular argument holds that the common monetary policy will lead to an increasing economic divergence in the euro area because of national inflation differentials which translate into national real interest rate differentials. We show that aggregate demand in the euro area countries is significantly affected by the euro area real interest rate, but not by national real interest rate differentials. --

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Bibliographic Info

Paper provided by ZEI - Center for European Integration Studies, University of Bonn in its series ZEI Working Papers with number B 29-2003.

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Date of creation: 2003
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Handle: RePEc:zbw:zeiwps:b292003

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Cited by:
  1. Hofmann, Boris & Remsperger, Hermann, 2005. "Inflation differentials among the Euro area countries: Potential causes and consequences," Journal of Asian Economics, Elsevier, vol. 16(3), pages 403-419, June.
  2. Andrzej Toroj, 2009. "Macroeconomic adjustment and heterogeneity in the euro area," National Bank of Poland Working Papers 54, National Bank of Poland, Economic Institute.
  3. Jean Louis, Rosmy & Balli, Faruk, 2013. "Low-inflation-targeting monetary policy and differential unemployment rate: Is monetary policy to be blamed for the financial crisis? — Evidence from major OECD countries," Economic Modelling, Elsevier, vol. 30(C), pages 546-564.
  4. Evzen Kocenda & Ali M. Kutan & Taner M. Yigit, 2005. "Pilgrims to the Eurozone: How Far, How Fast?," CERGE-EI Working Papers wp279, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  5. Carstensen, Kai & Gern, Klaus-Jürgen & Scheide, Joachim, 2007. "Konjunktur im Euroraum außerhalb Deutschlands bleibt aufwärts gerichtet," Open Access Publications from Kiel Institute for the World Economy 4002, Kiel Institute for the World Economy (IfW).
  6. Andrzej Toroj, 2008. "Estimation of weights for the Monetary Conditions Index in Poland," Working Papers 27, Department of Applied Econometrics, Warsaw School of Economics.

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