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Spain and the rest of the Euro Area differ in terms of growth and inflation performance

Javier Andres - Samuel Hurtado - Eva Ortega - Carlos Thomas: Spain in the Euro: A General Equlibrium Analysis Ágnes Csermely Magyar Nemzeti Bank. Scope of the paper. Spain and the rest of the Euro Area differ in terms of growth and inflation performance

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Spain and the rest of the Euro Area differ in terms of growth and inflation performance

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  1. Javier Andres - Samuel Hurtado - Eva Ortega - Carlos Thomas: Spain in the Euro: A General Equlibrium AnalysisÁgnes CsermelyMagyar Nemzeti Bank

  2. Scope of the paper • Spain and the rest of the Euro Area differ in terms of growth and inflation performance • Both average growth and average inflation are higher in Spain • Well-documented finding in the growth literature (convergence in income → convergence in prices) • Also: cyclical performances are different • Focus of this paper: What are the sources of cyclical differences?

  3. Aim of the project • To make use of BEMOD (Banco de Espana DSGE model) • To understand the sources of cyclical growth and inflation differentials • Asymmetric country-specific shocks vs. asymmetric economic structure • Effect of EMU membership on differentials

  4. Main results • Estimation reveals sizeable idiosyncratic shocks + differences in structural parameters • Cyclical (demeaned) growth differentials stem mostly from idiosyncratic shocks • Cyclical (demeaned) inflation differentials reflect both idiosyncratic shocks and asymmetric economic structure • Common shocks (i.e. oil prices) have different effects due to structural asymmetries • Independent monetary policy could have reduced cyclical differentials

  5. Why do we want to know the sources of differentials? • Should they be reduced? • Optimal currency area arguments suggest yes • Can we reduce them? • Yes, if they come from Spain-specific policy shocks or Spain-specific regulations • Are they dying out naturally in the convergence process? • Yes, if they come from differences in structural parameters that we believe to be related to initial conditions (more flexibility in price setting may reflect the higher inflation environment?)

  6. Structural interpretation • "They [DSGE models] have become popular [...] because the sources of fluctuations have clear structural interpretation." • Good news. But: do they really? • Some puzzling results: • Spain-specific mark-up shocks explain the bulk of CPI inflation in Spain and inflation differential to the Euro Area. • Most important shocks are those related to price and wage setting (cost-push shocks). • Nominal phenomena are explained residually?

  7. More story-telling is most welcome • Policymakers often find DSGE models too technical, analysis could rely more on intuition (story-telling) . • A DSGE statement: "A clear example is the year 2001, where the rest-of-the-World shocks had a positive effect on Spanish inflation but a negative effect on rest-of-EMU inflation." • A policymaker question: what exactly happened in 2001? • Was it rising oil prices (and Spain having a larger share of oil in production/consumption)? • Was it euro appreciation (and rest-of-EMU having of larger share of ROW-imports)? • Was it US recession (and rest-of-EMU being more relied on trade with the US)?

  8. Trend or cycle? • There is a clear positive average growth and inflation differential • We have reasons to believe that the differentials are non-stationary • A neoclassical convergence story would imply diminishing trend for differentials • Is simple demeaning the right way to stationarize the data?

  9. Predominant role for the supply-side • Very rich setup with emphasis on supply-side effects • The 21 structural shocks are mostly related to country-, sector- or investment-specific technologies • Demand-side effects are not very sophisticated • Ricardian fiscal policy shock • Time preference shock • If we are interested in the short run (cyclical properties), a more detailed view on the AD side would come useful • Non-Ricardian fiscal policy, relative preference shocks, and some financial intermediation ("domestic risk premium")

  10. Normative implications • Independent monetary policy in Spain would have reduced both inflation and growth differentials. • Common monetary policy is costly in terms of welfare • Role of fiscal policy becomes more important in smoothing out cyclical fluctuations • This calls for a more detailed and empirically more relevant view of fiscal policy in the model

  11. Conclusions • Differentials in growth and inflation persist over the longer run • Cyclical component of growth differentials come mostly from idiosyncratic shocks • Asymmetric policy measures should be reduced? • Cyclical component of inflation differentials come from both idiosyncratic shocks and structural asymmetries • With convergence, inflation should (by itself) become more synchronized?

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