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Interpreting inflation differentials in the euro area

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  • Enrique Alberola

Abstract

Since the start of Economic and Monetary Union (EMU), inflation differentials between the euro area countries have persisted, standing at around one percentage point in 1999. The differentials are relatively small and the evidence is that inflation differences on this scale are not infrequent between the regions of a country. But analysis of the determinants of divergent price developments between euro area countries is important for at least two reasons. First, inflation differentials in the euro area may be due both to (i) factors relating to disequilibrium and rigidities in the economy, in which case greater inflation would translate into a loss in competitiveness; and (ii) to a process of real and productivity-related convergence by the less developed countries towards the European average, where the inflation differentials would not prompt losses in competitiveness or macroeconomic disequilibria. These interpretations give rise to opposing views on the nature [worrying in (i), more benign in (ii)] of inflation differentials in a monetary union. Second, in a monetary union there is, by definition, no possibility of carrying out nominal adjustments domestically via monetary policy or the devaluation of the exchange rate. Were inflation differentials attributed to the more negative interpretation, i.e. were they to be associated with the existence of rigidities and disequilibria in the economy, there would be reasons for expecting the subsequent adjustment to have greater effects in real terms than when an autonomous monetary and exchange rate policy were in place. This article considers the theoretical arguments behind the two foregoing interpretations so as to assess as far as possible the nature of the inflation differences observed since the adoption of the single currency. One conclusion to emerge from the analysis is that the inflation differentials observed have arisen from both favourable and unfavourable factors, the relative significance of which is, unfortunately, difficult to quantify. In general, sustained processes of real convergence can be affirmed to be accompanied in the medium term by positive inflation differentials in relation to the more developed countries of the area. However, if the differentials are excessive, in that they reflect the influence of the inadequate functioning of markets or of demand-side disequilibria, convergence may be jeopardised.

Suggested Citation

  • Enrique Alberola, 2000. "Interpreting inflation differentials in the euro area," Economic Bulletin, Banco de España, issue APR, pages 61-70, April.
  • Handle: RePEc:bde:journl:y:2000:i:4:n:3
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    Citations

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    Cited by:

    1. Giorgio Canarella & Stephen Miller & Stephen Pollard, 2011. "The Global Financial Crisis and Stochastic Convergence in the Euro Area," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 17(3), pages 315-333, August.
    2. Pilar Beneito & Carlos Chafer, 2017. "Current Account Imbalances and Cost Competitiveness: The Role of the Euro," Working Papers 1703, Department of Applied Economics II, Universidad de Valencia.
    3. Faia, Ester & Campolmi, Alessia, 2006. "Cyclical inflation divergence and different labor market institutions in the EMU," Working Paper Series 619, European Central Bank.
    4. Marek Jarocinski, 2003. "Nominal and Real Convergence in Spain, Portugal and Greece During Their Accession to the EMU," CASE Network Studies and Analyses 0256, CASE-Center for Social and Economic Research.
    5. I. Arnold & C.J.M. Kool, 2004. "The Role of Inflation Differentials in Regional Adjustment: Evidence from the United States," Working Papers 04-13, Utrecht School of Economics.
    6. Angeloni Ignazio & Ehrmann Michael, 2007. "Euro Area Inflation Differentials," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-36, August.
    7. repec:kap:iaecre:v:17:y:2011:i:3:p:315-333 is not listed on IDEAS
    8. Nikolay Nenovsky & Kalin Hristov, 2001. "Official Eurozation of Bulgaria: Pluses and Minuses," Economic Studies journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 1, pages 64-80.
    9. Filippo Altissimo & Pierpaolo Benigno & Diego Palenzuela, 2011. "Inflation Differentials in a Currency Area: Facts, Explanations and Policy," Open Economies Review, Springer, vol. 22(2), pages 189-233, April.
    10. Pilar Beneito & Carlos Cháfer, 2020. "Capital Inflows and Costs: The Role of the Euro," Open Economies Review, Springer, vol. 31(5), pages 977-1008, November.
    11. 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.
    12. C.J.M. Kool, 2005. "What Drives ECB Monetary Policy?," Working Papers 05-03, Utrecht School of Economics.
    13. David López-Salido & Fernando Restoy & Javier Vallés, 2005. "Inflation differentials in EMU: the Spanish case," Working Papers 0514, Banco de España.

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