Long-Run Determinants of Inflation Differentials in a Monetary Union

Filippo Altissimo, Pierpaolo Benigno and Diego Rodriguez Palenzuela

No 5149, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper analyses the long-run determinants of inflation differentials in a monetary union. First, we aim at establishing some stylized facts relating the regional dispersion in headline inflation rates in the euro area as well as in the main components of the consumer price index. We find that a relatively large proportion of it occurs in the Service category of the EU?s harmonized consumer price index (HICP). We then lay out a model of a monetary union with fully flexible prices, the long-run properties of which are analysed. Our model departs in several respects from the Balassa-Samuelson hypotheses. Our results are in contrast with the result that movements in the real exchange rate are mainly driven by regionally asymmetric productivity shocks in the traded sectors. Our results point instead to relative variations in productivity in the non-traded sector as the primary cause of price and inflation differentials, with shocks to productivity in the traded sector being largely absorbed by movements in the terms of trade in the regional economies. These shocks are also found to largely drive the variability of real wages at the country level.

Keywords: Currency area; Real exchange rate; Ppp (search for similar items in EconPapers)
JEL-codes: E31 F41 (search for similar items in EconPapers)
Date: 2005-07
New Economics Papers: this item is included in nep-cba, nep-fmk, nep-mac, nep-mon and nep-sea
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Citations: View citations in EconPapers (47)

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Working Paper: Long-Run Determinants of Inflation Differentials in a Monetary Union (2005)
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