Inflation differentials in the EU: a common (factors) approach with implications for EU8 euro adoption prospects, Issues 2008-2021
International Monetary Fund, European Dept., 2008 - Business & Economics - 39 pages
This paper explores inflation determinants within the EU and implications for new members' euro adoption plans. Factor analysis partitions observed inflation in EU25 countries into common-origin and country-specific (idiosyncratic) components. Cross-country differences in common-origin inflation within the EU are found to depend on gaps in the initial price level, changes in the nominal effective exchange rate, the quality of institutions, and the economy's flexibility. Idiosyncratic inflation is generally small in magnitude. Nonetheless, the results show that country-specific shocks have systematically pushed down headline inflation, potentially influencing the assessment of compliance with the Maastricht inflation criterion.
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25 countries 25 EU countries common and idiosyncratic common components common shocks account common-origin component common-origin inflation differentials component is centered component of inflation core inflation covariance Czech Republic data set DFMs dynamic common factors effective exchange rate eigenvalues estimations Estonia EU8 countries euro area Eurostat factor models Figure flexible labor markets Fraser Institute GDFM headline and common-origin headline inflation idiosyncratic components indirect taxes Inflation Attributable inflation countries inflation rates inflation variability initial relative price labor market flexibility lags Latvia legal quality Lithuania long-term common-origin inflation Maastricht criterion Maastricht inflation criterion macroeconomic mean(x minimum(x Moreover negative idiosyncratic shocks nominal effective depreciation nominal effective exchange number of common numeraire open economies origin inflation Palenzuela percent percentage points Political instability CNTS price gaps principal component Product market flexibility Redefined as sample reference rate relative price level sample mean Slovak Republic Slovenia spectral density matrices static factors trade openness