Inflation and Wage Behaviour in Europe

Inflation and Wage Behaviour in Europe

Inflation and Wage Behaviour in Europe

Inflation and Wage Behaviour in Europe

Synopsis

The purpose of this collection is to shed light on the processes that lead to convergence or divergence in national inflation rates. It examines inflation and wage behavior in the European Monetary System (EMS), their determinants, and their implications for the credibility and sustainability of the system's exchange rate mechanism (ERM). The contributors examine issues of monetary control, stability of national and ERM-wide money-demand functions, and the influence of the monetary policy of Germany - the pivotal country in the EMS. They identify several causes of inflation and persistent inflation differentials in the EMS. As well as explaining how the EMS worked, the book also offers reasons for its breakdown in 1992-3 under the blow of exogenous shocks and growing policy conflict between member countries.

Excerpt

In the Maastricht Treaty, convergence of inflation rates has been made one of the necessary conditions for the start of European Monetary Union (EMU) in Europe. It is therefore of great importance to understand the mechanism underlying the processes that lead to convergence or divergence in national inflation rates. the purpose of this study is to shed light on this issue.

This book contains twelve essays that study inflation and wage behaviour in the European Monetary System (EMS), their determinants, and their implications for the credibility and sustainability of the system's exchange rate arrangements (ERM). Direct evidence on wage and price formation and on expectations of selling prices is supplemented by indirect evidence on expectations from interest rate differentials. Issues of monetary control, notably as regards the stability of money demand in the erm area, and the monetary policy of the pivot-country of the System, Germany, are also examined.

While these studies were being completed, the erm broke down, in 1992-3, under the blow of real exogenous shocks (German unification) and growing policy conflict between member countries: however, the root causes of the breakdown seem to lie in price rigidities and divergent price levels and inflation rates. Thus, with hindsight, these studies take up added significance for the analyses and the insights they provided on the 'real' limitations of quasi-fixed exchange rates in ensuring price convergence.

Although the focus is on the ems period, eleven out of twelve studies also cover the 1970s, mostly with the aim of verifying the existence of breaks in the estimated price and wage equations. These breaks, if they occur, are then associated either with the increased influence of Germany on other member countries and hence increased credibility of the then prevailing exchange rate parities, significant changes in domestic economic policies, or exogenous shocks like oil shocks.

One study also deals, among other topics, with foreign influences on expectations of German selling prices (De Jong, Chapter 10), and finds evidence in favour of the hypothesis that after 1984, forecasts based on the pre-1984 regressions systematically underpredict actual expectations of German selling prices, a sign that as the ems became more credible, even Germany was not completely immune from other members' influences. Furthermore, several studies in this volume find that between 1982 and 1985 structural breaks (or significant changes in the coefficients of German variables) occurred in the equations determining inflation, expectations of inflation, wages and interest rates in France, Italy, and Belgium, suggesting that the exchange rate bands and hence the ems acquired a significant degree of credibility only three to six years after its inception. For the Netherlands no major breaks were found by . . .

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