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Inflation’s comeback

Huttl, Pia, (2017), «Inflation’s comeback», Bruegel, 13 Φεβρουαρίου

Before the financial crisis, a standard assumption was that the southern peripheral countries were on a path to converge their income per capita to northern levels, and as such, through Balassa-Samuelson effects (describing how increase in traded-goods-sector productivity in the South bids up the price of non-traded goods there, relative to abroad), experiencing faster inflation. The ‘below, but close to’ 2% target of the ECB was fine for the conservative north, since it meant that hitting 2 per cent inflation in the Eurozone as a whole would actually imply <2 per cent for them.

However, after the crisis, the southern story looks rather different. It turns out that the price of non-traded goods was being pushed up not by durable increases in productivity, but by excessive domestic demand, fueled by borrowing against future income that was not going to arrive, and facilitated by spreads that were too low. The south has now been embarking on a protracted and painful internal devaluation.

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