Cross-Country Inflation Dynamics in the Eurozone, 1979-2017

Abstract

Inflation heterogeneity has been in discussion since the advent of the European monetary union, but little has been said about the interactions between the price levels of different countries. This paper estimates a Bayesian vector autoregression to examine cross-country inflation dynamics in the 12 largest Eurozone countries ordered by GDP size. I use price level data from 1979 to 2017 to assess whether the introduction of the euro reduced these effects. I find evidence for significant cross-country interactions. Short-term responses to shocks in inflation from other countries persist across the area, even after euro adoption. In addition, the inflation rates of several countries become more influential to the price levels of the rest of the Eurozone post-euro, which is counterintuitive given the European Central Bank's central goal of price stability. The results imply that the single monetary policy likely affects participating countries unevenly, which may exacerbate imbalances in the area.