Catching-Up and Inflation in Europe: Balassa-Samuelson, Engel’s Law and Other Culprits

Abstract:     
This study analyses the impact of economic catching-up on annual inflation rates in the European Union with a special focus on the new member countries of Central and Eastern Europe. Using an array of estimation methods, we show that the Balassa-Samuelson effect is not an important driver of inflation rates. By contrast, we find that the initial price level and regulated prices strongly affect inflation outcomes in a nonlinear manner and that the extension of Engel’s Law may hold during periods of very fast growth. We interpret these results as a sign that price level convergence comes from goods, market and non-market service prices. Furthermore, we find that the Phillips curve flattens with a decline in the inflation rate, that inflation is more persistent and that commodity prices have a stronger effect on inflation in a higher inflation environment.

Number of Pages in PDF File: 34

Keywords: European Union, Inflation, Balassa-Samuelson, Real Convergence, Catching Up, Bayesian Model Average, Non-Linearity

JEL Classification: E43, E50, E52, C22, G21, O52

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