A Mechanism of Inflation Differentials and Current Account Imbalances in the Euro Area

Harashima, Taiji (2011): A Mechanism of Inflation Differentials and Current Account Imbalances in the Euro Area.

Abstract

This paper examines the mechanism of persistent inflation differentials, current account imbalances, and fiscal deficits in the euro area by constructing a multi-country model in which the optimization behaviors of governments as well as those of households, firms, and the European Central Bank are explicitly incorporated. The model indicates that governments can temporarily adhere to their own intrinsic preferences because fiscal policies are not unified in the euro area. This behavior generates problems, such as inflation differentials, and the stability and growth pact does not appear to be sufficiently effective in preventing such deviations. The results in this paper imply that the balance between national sovereignty and economic stability should be shifted more to the side of stability and that the euro area has to become more politically unified. In addition, the inflation differentials provide clear evidence that inflation acceleration is not caused by monetary policies but by government behavior because monetary policies are unified in the euro area whereas fiscal policies are not.

• Item Type: MPRA Paper
• Language: English
• Keywords: The euro; Monetary union; Inflation; Inflation differential; Current account imbalance; Fiscal deficit; Time preference; The European Central Bank; The stability and growth pact
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy ; Stabilization ; Treasury Policy; F - International Economics > F3 - International Finance > F33 - International Monetary Arrangements and Institutions; O - Economic Development, Innovation, Technological Change, and Growth > O5 - Economywide Country Studies > O52 - Europe; N - Economic History > N1 - Macroeconomics and Monetary Economics ; Industrial Structure ; Growth ; Fluctuations > N14 - Europe: 1913-

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