"Inflation differentials across regions of an integrated economy can reflect a proper response to demand and supply conditions, but can also indicate distortions with negative welfare implications. Using a novel dataset of regional inflation rates from six euro area countries, we examine the size and persistence of their differentials and find that they appear to be related to factor market distortions and other structural characteristics, rather than to cyclical and growth dynamics. Our empirical analysis shows that only about half of inflation rates variation is accounted for by area-wide factors such as monetary policy or oil price developments. National factors (such as labour market institutions) still play a very important role, and a regional component accounts for about 18% of inflation variability." Copyright (c) CEPR, CES, MSH, 2009.

Abstract:We use consumer price data for 81 European cities (in Germany, Austria, Switzerland, Italy, Spain and Portugal) to study deviations from the law-of-one-price before and during the European Economic and Monetary Union (EMU) by analysing both aggregate and disaggregate CPI data for 7 categories of goods we find that the distance between cities explains a significant amount of the variation in the prices of similar goods in different locations. We also find that the variation of the relative price is much higher for two cities located in different countries than for two equidistant cities in the same country. Under EMU, the elimination of nominal exchange rate volatility has largely reduced these border effects, but distance and border still matter for intra-European relative price volatility.Keywords: relative price volatility, spatial data, real exchange rate, law of one price, purchasing power parity, stationarity, panel unit root test JEL classification: F40, F41 -2 -

The European Central Bank (ECB) has assigned a special role to money in its two‐pillar strategy and has received much criticism for this decision. The case against including money in the central bank's interest rate rule is based on a standard model of the monetary transmission process that underlies many contributions to research on monetary policy in the last two decades. In this paper, we develop a justification for including money in the interest rate rule by allowing for imperfect knowledge regarding unobservables such as potential output and equilibrium interest rates. We formulate a novel characterization of ECB‐style monetary cross‐checking and show that it can generate substantial stabilization benefits in the event of persistent policy misperceptions regarding potential output. (JEL: E32, E41, E43, E52, E58)

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This paper can be downloaded without charge from http://www.ecb.europa.eu or from the Social Science Research Network electronic library at http://ssrn.com/abstract_id=1295987.