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Catching-up and inflation differentials in a heterogeneous monetary union: Some implications for the euro area and new EU Member States

  • MacDonald, Ronald
  • Wójcik, Cezary

We propose an alternative explanation for the nature, sources and consequences of inflation rate differentials in a monetary union, such as the euro area. We build on the new neoclassical synthesis (NNS) framework, recently advanced by Goodfriend [Goodfriend, M. 2002. Monetary Policy in the New Neoclassical Synthesis: A Primer. Federal Reserve Bank of Richmond, Richmond, VA] and Goodfriend and King [Goodfriend, M., King, R., 2001. Case for price stability. NBER Working Paper 8423, Cambridge, MA]. Based on the NNS setup, we discuss the inflationary consequences of the catching-up process in a heterogeneous monetary union. In particular, we explore the interaction between catching-up and inflation differentials and offer an interpretation of the nature of this interaction. We demonstrate that divergent inflation rates between Member States do not necessarily have to be an equilibrium phenomenon, even if the original shock comes from the supply-side of the economy. Second, we show how such divergence of individual country's inflation rates may arise when countries differ in size and in trend productivity growth.

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Article provided by Elsevier in its journal Economic Systems.

Volume (Year): 32 (2008)
Issue (Month): 1 (March)
Pages: 4-16

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Handle: RePEc:eee:ecosys:v:32:y:2008:i:1:p:4-16
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  1. Bela Balassa, 1964. "The Purchasing-Power Parity Doctrine: A Reappraisal," Journal of Political Economy, University of Chicago Press, vol. 72, pages 584.
  2. Bergstrand, Jeffrey H, 1991. "Structural Determinants of Real Exchange Rates and National Price Levels: Some Empirical Evidence," American Economic Review, American Economic Association, vol. 81(1), pages 325-34, March.
  3. Patrick Honohan & Philip R. Lane, 2003. "Divergent inflation rates in EMU," Economic Policy, CEPR;CES;MSH, vol. 18(37), pages 357-394, October.
  4. Marvin Goodfriend & Robert G. King, 2001. "The case for price stability," Working Paper 01-02, Federal Reserve Bank of Richmond.
  5. Neary, Peter, 1988. "Determinants of the Equilibrium Real Exchange Rate," American Economic Review, American Economic Association, vol. 78(1), pages 210-15, March.
  6. Ken Froot & Kenneth Rogoff, . "Perspectives on PPP and Long-Run Real Exchange Rates," Working Paper 32027, Harvard University OpenScholar.
  7. Goodfriend, Marvin, 2002. "Monetary Policy in the New Neoclassical Synthesis: A Primer," International Finance, Wiley Blackwell, vol. 5(2), pages 165-91, Summer.
  8. De Gregorio, Jose & Giovannini, Alberto & Wolf, Holger C., 1994. "International evidence on tradables and nontradables inflation," European Economic Review, Elsevier, vol. 38(6), pages 1225-1244, June.
  9. Paul Bergin & Reuven Glick & Alan M. Taylor, 2004. "Productivity, tradability, and the long-run price puzzle," Working Paper Series 2004-08, Federal Reserve Bank of San Francisco.
  10. Leon Podkaminer, 2003. "Analytical notes on the Balassa-Samuelson effect," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 56(226), pages 207-221.
  11. Canzoneri, Matthew B & Diba, Behzad & Fudey, Gwen, 1996. "Trends in European Productivity and Real Exchange Rates: Implications for the Maastricht Convergence Criteria and for Inflation Targets after EMU," CEPR Discussion Papers 1417, C.E.P.R. Discussion Papers.
  12. De Grauwe, Paul, 1992. "Inflation Convergence During the Transition to EMU," CEPR Discussion Papers 658, C.E.P.R. Discussion Papers.
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