This paper provides a comprehensive review of the factors that can cause price levels to diverge and which are at the root of different inflation rates in Europe including the EU-27. Among others, the author studies the structural and cyclical factors influencing market and non-market-based service, house and goods prices and summarises some stylised facts emerging from descriptive statistics. Subsequently, the author sets out the possible mismatches between price level convergence and inflation rates. Having the relative importance of these factors on observed inflation rates first in an accounting framework and then by relying on panel estimations. Cyclical effects and regulated prices are found to be important drivers of inflation rates in an enlarged Europe. House prices matter to some extent in the euro area, whereas the exchange rate plays a prominent (but declining) role in transition economies.
An earlier version of the paper was published as Bruegel Working Paper No 2/2007. This version contains a larger dataset and new estimation results.
Working Paper 138
Real Convergence, Price Level Convergence and Inflation Differentials in Europe
July 5, 2007
The opinions are strictly those of the authors and in no way commit the OeNB.
Working Paper 138 (707 KB)