Long-Run Determinants of Inflation Differentials in a Monetary Union

38 Pages Posted: 9 Aug 2005 Last revised: 23 Jul 2009

See all articles by Filippo Altissimo

Filippo Altissimo

Brevan Howard Asset Management LLP

Pierpaolo Benigno

New York University - Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Diego Rodriguez-Palenzuela

European Central Bank (ECB)

Multiple version iconThere are 2 versions of this paper

Date Written: July 2005

Abstract

This paper analyzes the long-run determinants of inflation differentials in a monetary union. First, we aim at establishingsome 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.

Suggested Citation

Altissimo, Filippo and Benigno, Pierpaolo and Rodriguez-Palenzuela, Diego, Long-Run Determinants of Inflation Differentials in a Monetary Union (July 2005). NBER Working Paper No. w11473. Available at SSRN: https://ssrn.com/abstract=760166

Filippo Altissimo

Brevan Howard Asset Management LLP ( email )

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Pierpaolo Benigno (Contact Author)

New York University - Stern School of Business ( email )

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HOME PAGE: http://homepages.nyu.edu/~pb50

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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Diego Rodriguez-Palenzuela

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
(49) 69-1344-6480 (Phone)
(49) 69-1344-6575 (Fax) (Fax)

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