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The Inflation Target of the ECB: Does the Balassa-Samuelson Effect Matter?

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  • Kirsten Lommatzsch
  • Silke Tober

Abstract

This paper argues that the Balassa-Samuelson effect is not of importance for the inflation target of the ECB. First, econometric tests of the Balassa-Samuelson effect suggest that its econometric significance is weak at best. Second, countries in the process of catching up require a real devaluation in the sector of tradable goods to maintain balance-of-payments equilibrium which counters the real appreciation resulting from a relative increase in service prices. It follows that whereas the Balassa-Samuelson effect could, at least in theory, be used to justify an inflation target well above zero, thedifference in productivity growth and thus the difference in the size of the Balassa-Samuelson effect between countries as such cannot.

Suggested Citation

  • Kirsten Lommatzsch & Silke Tober, 2004. "The Inflation Target of the ECB: Does the Balassa-Samuelson Effect Matter?," EUI-RSCAS Working Papers 19, European University Institute (EUI), Robert Schuman Centre of Advanced Studies (RSCAS).
  • Handle: RePEc:erp:euirsc:p0136
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    References listed on IDEAS

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    1. Paul De Grauwe, 2002. "Challenges for Monetary Policy in Euroland," Journal of Common Market Studies, Wiley Blackwell, vol. 40(4), pages 693-718, November.
    2. Mishkin, Frederic S., 1998. "International Experiences With Different Monetary Policy Regimes," Seminar Papers 648, Stockholm University, Institute for International Economic Studies.
    3. Engle, Robert & Granger, Clive, 2015. "Co-integration and error correction: Representation, estimation, and testing," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 39(3), pages 106-135.
    4. Mark A. Wynne & Diego Rodriguez-Palenzuela, 2004. "Measurement Bias in the HICP: What do we know and What do we need to know?," Journal of Economic Surveys, Wiley Blackwell, vol. 18(1), pages 79-112, February.
    5. Artis, Michael J & Mizen, Paul & Kontolemis, Zenon, 1998. "Inflation Targeting: What Can the ECB Learn from the Recent Experience of the Bank of England?," Economic Journal, Royal Economic Society, vol. 108(451), pages 1810-1825, November.
    6. 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.
    7. Gerlach, Stefan & Svensson, Lars E. O., 2003. "Money and inflation in the euro area: A case for monetary indicators?," Journal of Monetary Economics, Elsevier, vol. 50(8), pages 1649-1672, November.
    8. Matthew Canzoneri & Robert Cumby & Behzad Diba & Gwen Eudey, 1998. "Trends in European Productivity: Implications for Real Exchange Rates, Real Interest Rates and Inflation Differentials," Working Papers 27, Oesterreichische Nationalbank (Austrian Central Bank).
    9. Michael Reutter & Hans-Werner Sinn, 2000. "The Minimum Inflation Rate for Euroland," CESifo Working Paper Series 377, CESifo Group Munich.
    10. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," Journal of Economic Perspectives, American Economic Association, vol. 11(2), pages 97-116, Spring.
    11. Jose De Gregorio & Holger C. Wolf, 1994. "Terms of Trade, Productivity, and the Real Exchange Rate," NBER Working Papers 4807, National Bureau of Economic Research, Inc.
    12. John H. Rogers & Gary Clyde Hufbauer & Erika Wada, 2001. "Price Level Convergence and Inflation in Europe," Working Paper Series WP01-1, Peterson Institute for International Economics.
    13. DeLoach, Stephen B, 2001. "More Evidence in Favor of the Balassa-Samuelson Hypothesis," Review of International Economics, Wiley Blackwell, vol. 9(2), pages 336-342, May.
    14. International Monetary Fund, 2002. "Monetary and Exchange Rate Policies of the Euro Area; Selected Issues," IMF Staff Country Reports 02/236, International Monetary Fund.
    15. Canzoneri, Matthew, et al, 2002. "Productivity Trends in Europe: Implications for Real Exchange Rates, Real Interest Rates, and Inflation," Review of International Economics, Wiley Blackwell, vol. 10(3), pages 497-516, August.
    16. Lommatzsch, Kirsten & Tober, Silke, 2004. "What is behind the real appreciation of the accession countries' currencies?: An investigation of the PPI-based real exchange rate," Economic Systems, Elsevier, vol. 28(4), pages 383-403, December.
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    Citations

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    Cited by:

    1. Balázs Égert & László Halpern & Ronald MacDonald, 2006. "Equilibrium Exchange Rates in Transition Economies: Taking Stock of the Issues ," Journal of Economic Surveys, Wiley Blackwell, vol. 20(2), pages 257-324, April.
    2. Egert, Balazs, 2005. "Equilibrium exchange rates in South Eastern Europe, Russia, Ukraine and Turkey: Healthy or (Dutch) diseased?," Economic Systems, Elsevier, vol. 29(2), pages 205-241, June.
    3. Ulrich Fritsche & Camille Logeay & Kirsten Lommatzsch & Katja Rietzler & Sabine Stephan & Rudolf Zwiener unter Mitarb. von Cansel Kiziltepe & Christian Proano-Acosta, 2005. "Auswirkungen von länderspezifischen Differenzen in der Lohn-, Preisniveau- und Produktivitätsentwicklung auf Wachstum und Beschäftigung in den Ländern des Euroraums: Endbericht ; Forschungsprojekt im ," DIW Berlin: Politikberatung kompakt, DIW Berlin, German Institute for Economic Research, volume 8, number pbk8.
    4. Balazs Egert & Amina Lahrèche-Révil & Kirsten Lommatzsch, 2004. "The Stock-Flow Approach to the Real Exchange Rate of CEE Transition Economies," Working Papers 2004-15, CEPII research center.
    5. Balázs Égert, 2005. "Balassa-Samuelson Meets South Eastern Europe, the CIS and Turkey: A Close Encounter of the Third Kind?," European Journal of Comparative Economics, Cattaneo University (LIUC), vol. 2(2), pages 221-243, December.
    6. Sabine Le Bayon, 2006. "La croissance espagnole est-elle soutenable ?," Sciences Po publications info:hdl:2441/2822, Sciences Po.
    7. repec:onb:oenbfi:y:2004:i:2:b:6 is not listed on IDEAS
    8. Christian Proaño Acosta, 2007. "Inflation Differentials and Business Cycle Fluctuations in the European Monetary Union," IMK Working Paper 05-2007, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
    9. Balázs Égert, 2004. "Equilibrium Exchange Rates in Southeastern Europe, Russia, Ukraine and Turkey: Healthy or (Dutch) Diseased?," Focus on European Economic Integration, Oesterreichische Nationalbank (Austrian Central Bank), issue 2, pages 138-181.

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    Keywords

    European Central Bank; EMU; international trade;

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