Inflation in a Monetary Union

This book presents a systematic, and schematic, study of the determinants of inflation in a monetary union. The results are derived from a dynamic, steady state growth version of a full employment, neoclassical synthesis type of model. The reader is carefully conducted through a step‐wise analysis: first, a closed economy is considered; second, a two‐country model, with flexible exchange rates and imperfect substitutability between the goods produced in the two regions; finally, a monetary union formed by two countries, with flexible exchange rates towards a third one, representing the rest of the world. Numerical examples offer further guidance in understanding the results. These are then contrasted with those derived in a one‐good model of the world economy (with the demand side condensed to a quantity theory equation). Finally, the last part of the book offers some microeconomic foundations, based upon the household utility maximisation subject to the budget constraint. The main results concern inflation, depreciation, wage growth and interest rates; the case of the central bank targeting inflation is also considered, with the consequent focus on the required money growth rate. For the sake of brevity, I will concentrate on the results concerning the open economy framework, starting with the case of the world consisting of two countries, with flexible exchange rates. In either of them, producer inflation is given by the difference between the money and income growth rates. Nominal depreciation results from the difference between the money growth rates of the two countries: the author stresses the contrast with the ‘widely held view’ (page 48) that the nominal depreciation rate depends on producer inflation. One should note, however, that this result is indeed correct in some cases, for instance in the absence of output growth or in the one‐good set‐up used by the author in Part IV of the book. The same holds for the nominal interest rates differential (while the real one is given by the difference in the countries’ output growth rates). As for consumer inflation, it depends positively on the country's money growth rate and negatively on those of home and foreign output; note that in the one‐good model there is no difference between producer and consumer inflation, that, therefore, is independent of the foreign output growth rate. Wage growth may be driven by productivity growth or labour growth; in the first case, nominal wages growth is determined by money growth; producer real wages growth by productivity growth; and consumer real wages growth by productivity growth in both countries; as for the case of labour growth, nominal wages grow according to the difference between the money and the labour force growth rates; producer real wages do not change; consumer real wage growth is determined by the differential between the foreign and home labour force growth rates

Economics · Inflation (cosmology · Keynesian economics · Monetary economics · Monetary policy · Physics · European Monetary and Fiscal Policies