Monetary Policy Challenges of the ECB Facing a Divergent Inflationary Process in the EMU Area
MACROECONOMIC, FINANCE AND MONEY: ESSAYS IN HONOUR OF PHILIP ARESTIS, Giuseppe Fontana, John McCombie and Malcolm Sawyer, eds., Palgrave, Forthcoming
21 Pages Posted: 17 Jul 2009 Last revised: 5 Apr 2017
Date Written: June 25, 2009
The creation of the European Monetary Union has been celebrated as one of the key accomplishments of the European integration process. However, it has always been pointed out by many economists that it was first and for all a political decision to shield the Eurozone better against turmoil in global financial markets and protect its members against unwarranted exchange rate shocks which plagued the previous European Monetary System. The Maastricht treaty together with the Stability and Growth Pact and a lengthy convergence process between potential members should assure that a sufficient degree of convergence between its members with regard to price stability will be accomplished. After a little more than a decade it is time to make an assessment how far these aims have been fulfilled by the factual development. This paper studies the degree of convergence of inflation dynamics using monthly Harmonized Consumer Price Indices (HICP) for the different countries as the empirical database. Although a joint common commodity basket seems to be more appropriate, since the national differences in the consumption patterns tend to produce biased results, in particular when the national commodity baskets differ significantly and change differently over time, we test forb- and/or s-convergence of national inflation rates inside the Eurozone. We find that there is still a considerable degree of heterogeneity prevailing in the national inflation rates. However, the stochastic long-term convergence might be accomplished after a sufficiently long time period. The optimistic view that this convergence would happen much more rapidly is, however, refuted by the empirical and econometric analysis. In particular, Germany as one of the major member states has maintained a persistent disinflationary bias to the overall Eurozone inflation trend rate. Linked to Germany, Austria and France follow this behaviour to some extent. One reason might be the fear of loosing competitiveness against Germany. Another interesting finding of our analysis is that the UK, Denmark and Sweden which have not become members of the Eurozone could enter it without any major difficulty with regard to their national inflation dynamics. Finally, one can observe that the actual shock of the global financial and economic crisis has led to a convergence shock in disinflation across the EU-countries included in our analysis.
Keywords: Eurozone, convergence, inflation, sustainability, monetary policy
JEL Classification: E01, E31, E42
Suggested Citation: Suggested Citation