Working Paper

Inflation Differentials in the Euroa Area and Their Determinants – An Empirical View

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In this paper, we present evidence on the statistical features of observed dispersion in HICP inflation
rates in the Euro area. Our descriptive exercise shows that there is still a remarkable dispersion of HICP
inflation rates across the member countries. We find that most of dispersion originates in the non-traded
categories of the HICP. This suggests that the main source of dispersion in countries’ headline inflation
rates is in those components of the HICP where non-traded goods (services, (public) goods with regulated
and administered prices) are more intensely represented. We then examine the determinants of inflation
differentials in a panel of the states of the Euro area in 1999–2007 using alternative classifications of this
group and three different datasets. The evidence presented shows that output gaps and a proxy for price
level convergence were statistically significant. On the other hand, some determinants that were found
significant in previous studies (for example Honohan and Lane 2003, 2004; ECB, 2003) has no impact on
inflation in our expanded time span (e.g. exchange rate movements)
The dispersion of HICP inflation is expected to increase in the coming years as the new EU member
states will join the Euro area. There are some risks for these countries connected with the common
monetary policy, which is adjusted more to the conditions of stabilized advanced economies forming the
core of the Euro area. This creates potential problems for the EU common monetary policy (ECB), in
particular negative (positive) interest rates, their repercussions on investment processes, consumption and
the possibility of creating asset bubbles.


Václav Zdarek
Juan Ignacio Aldasoro


Publication Date
JEL Classification
C23, E31, F15, F41