Working Paper: NBER ID: w11473
Authors: Filippo Altissimo; Pierpaolo Benigno; Diego Rodriguez Palenzuela
Abstract: This paper analyzes the long-run determinants of inflation differentials in a monetary union. First, we aim at establishing \nsome 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 analyzed. Our model departs in several respect 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: Inflation Differentials; Monetary Union; Euro Area; Productivity Shocks
JEL Codes: E31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Relative variations in productivity in the nontraded sector (O49) | Inflation differentials (E31) |
| Productivity shocks in the nontraded sector (O49) | Inflation rates (E31) |
| Government spending shocks (E62) | Price differentials (L11) |
| Asymmetric productivity shocks (O49) | Inflation differentials (E31) |
| Productivity shocks in the traded sector (F41) | Terms of trade movements (F14) |