Inflation Differentials in Europe. Balázs Égert Economics Department, OECD

Inflation Differentials in Europe Balázs Égert Economics Department, OECD

Objectives of the presentation Different factors driving inflation rates in Europe Differences between mature and catching-up countries

Balassa-Samuelson Puzzle I. Large productivity gains in the tradable sector and yet low Balassa- Samuelson effect in the CPI

The Balassa-Samuelson Puzzle 10 8 B-S effect inflation 1997-2005 inflation 2005 6 4 2 0-2 Czech Republic Estonia Latvia Lithuania Hungary Poland Slovenia Slovakia Bulgaria Romania Source: based on Égert, Halpern and MacDonald (2005)

Balassa-Samuelson Puzzle II. Large literature showing low B-S effect and yet policymakers still argue in terms of the Balassa-Samuelson effect

The Balassa-Samuelson Puzzle 4 elements of the puzzle

The Balassa-Samuelson Puzzle Large dispersion of productivity gains in tradables Productivity <->Wages Incomplete wage equalization Large productivity gains in nontradables Low share of market-based nontradables in the CPI

Large Dispersion of Productivity Growth in Manufacturing Figure 6. Dispersion of Productivity Growth in Manufacturing 20% 18% 16% 14% productivity grow th SD of productivity grow th w ithin manufacturing 12% 10% 8% 6% 4% 2% 0% FI SE BE NL DE PT euro area FR DK ES IT HU PL SI -2 SK HU - 2 BG CZ CZ - 2 HR RO SI

Wage Equalisation Figure 2c. Difference between annual gross nominal wage growth in market services and manufacturing (1995-2005) 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% -2.0% -2.5% Romania Bulgaria Slovenia Hungary Slovakia Poland Croatia Czech Rep

18 16 14 12 10 8 6 4 2 0-2 Large Productivity Gains in Nontradables (1995-2005) Euro area Austria Belgium France Germany Netherlands Finland Italy Ireland Greece Portugal Spain Denmark Sweden UK Cyprus Czech Rep. Hungary Poland Slovakia Slovenia Estonia Latvia Lithuania Croatia Romania TRADABLES NONTRADABLES

Low Share of Market Nontradables in CPI Simple accounting framework p B S = (1 α )( prod T prod NT )

40 35 30 25 20 15 10 5 0 Euro area AT BE DE FR NL LU FI IT IE ES PT GR SE UK DK CY MT CZ HU PL SK SI EE LV LT BG RO TR Low Share of Market Nontradables in the CPI (2005) Western Europe CEE

Implications For the inflation rate For the real exchange rate

Structural factors Services/nontradable goods The usual suspect: Balassa- Samuelson Administered/regulated prices Residential property prices Tradable goods prices

Tradable Goods Quality increases Extension of Engel s Law: richer households consume goods of better quality than poorer household; Real convergence => higher share of goods of higher quality => higher price

Tradable Goods Quality increases same good example (from 2005): cherry tomato (origin Israel) Hungary: 250g, 119 HUF (0.40-0.50 EUR); 2. class Austria: 250g, 0.99 1.59 EUR; 1. class

1.2 1.1 Pricing-to-Market Practices => cars (very homogenous goods) Figure 12. The Relative Price Level of Cars (euro area=1, 2006) euro area price level (VAT included) = 1 Tradable Goods segment B segment C segment D segment E segment F 1.0 0.9 0.8 be at ie fr pt nl es it fi gr de se uk dk cy mt cz pl sk lv lt ee si hu

Tradable Goods Distribution Sector 12%. Productivity Growth in the Distribution Sector, Annual Averages, 1995-2004 10% 8% 6% 4% 2% 0% -2% FI NL LU DE BE IT FR IE SE DK CZ LV LT EE PL SI HU SK

Empirical Exercise Panel estimations Annual data Euro area + CEE countries

STRUCTURAL FACTORS BALASSA-SAMUELSON EFFECT B-S WIDE (CONST.) B-S NARROW (CONST.) PRODUCTIVITY DIFF. REGULATED PRICES 3 measures OTHER STRUCTURAL FACTORS SHARE OF RECREATION IN THE HICP SHARE OF FOOD IN THE HICP REAL FINAL HOUSHOLD CONSUMPTION PRICE LEVEL 97 (CONST.)

CYCLICAL FACTORS 2 measures of OUTPUT GAP ULC GOV. SURPLUS/DEFICIT EXTERNAL FACTORS OIL PRICE NEER OTHER FACTORS HOUSE PRICES VAT INCREASES AND DECREASES MONETARY AGGREGATES

CYCLICAL FACTORS 2 measures of OUTPUT GAP ULC GOV. SURPLUS/DEFICIT EXTERNAL FACTORS PRICE OF OIL EXCHANGE RATE and OPENNESS OTHER FACTORS HOUSE PRICES VAT INCREASES AND DECREASES MONETARY AGGREGATES

CYCLICAL FACTORS 2 measures of OUTPUT GAP ULC GOV. SURPLUS/DEFICIT EXTERNAL FACTORS OIL PRICE NEER OTHER FACTORS HOUSE PRICES VAT INCREASES AND DECREASES MONETARY AGGREGATES

Table 13b. Euro Area (excluding Luxembourg) + CEE-10 Dependent variable: annual change in the HICP: P t = f (X ) 1999-2005 Regulated prices excluded House prices included House prices excluded GMM GMM GMM OLS OLS OLS OLS GMM GMM GMM GMM OLS OLS CONSTANT 0.781*** 0.817*** 0.843*** 0.796*** 2.134*** 1.896*** INFLATION (-1) 0.200*** 0.276*** 0.255*** 0.301*** 0.302*** 0.319*** 0.320*** 0.306*** 0.307*** 0.228*** 0.198*** 0.242*** 0.244*** CYCLICAL FACTORS OUTPUT GAP1 0.394**** 0.195*** 0.176*** 0.321*** 0.271*** 0.182** OUTPUT GAP2 0.367*** 0.296*** 0.180*** 0.201*** 0.322*** 0.284*** 0.164*** ULC GOV. SURPLUS/DEFICIT -0.106*** -0.064*** BALASSA-SAMUELSON EFFECT B-S WIDE (CONST.) -0.257** -0.283*** B-S NARROW (CONST.) -0.328** -0.351*** PRODUCTIVITY DIFF. REGULATED PRICES REG1 0.351*** 0.397*** 0.268*** 0.266** 0.273*** 0.276*** 0.223*** 0.269*** 0.182*** 0.187*** 0.221*** 0.229*** REG2 REG3 0.310*** OTHER STRUCTURAL FACTORS SHARE OF RECREATION IN THE HICP SHARE OF FOOD IN THE HICP -0.016* -0.034** REAL FINAL HOUSHOLD CONSO PRICE LEVEL 97 (CONST.) -1.199** -0.922* GDP PER CAPITA 0.042*** 0.021*** EXTERNAL FACTORS OIL PRICE (-1) 0.009*** 0.009*** 0.009*** 0.006*** 0.008*** 0.006*** 0.009** 0.009** NEER -0.129** -0.206** NEER (-1) -0.113*** -0.116*** -0.153*** -0.205*** OTHER FACTORS MONETARY AGGREGATES HOUSE PRICES 0.007*** 0.007*** 0.022** 0.017** 0.018** 0.014** 0.013** VAT INCREASES VAT DECREASES R2-adj 0.271 0.380 0.091 0.778 0.778 0.775 0.774 0.411 0.545 0.201 0.268 0.765 0.641 Jarque-Bera normality test (p-value) 0.014 0.116 0.000 0.747 0.717 0.787 0.854 0.000 0.000 0.000 0.000 0.000 0.038 No. of OBS 91 93 91 107 107 107 107 119 119 123 123 134 134 No. of COUNTRIES 17 17 17 17 17 17 17 21 21 21 21 21 21 Notes: See Table 11. 4

Conclusion Cyclical and external factors are very important Structural factors are also important services + goods but B-S effect is not very important