Inflation Dynamics in Countries of the Monetary Union: What is its Impact on the Common Economic Policy?

Abstract

Inflation Dynamics in Countries of the Monetary Union: What is its Impact on the Common Economic Policy?This paper studies the impact of inflation dynamics on a common economic policy in the monetary union using a small New Keynesian model of the monetary union. We are considering two open economy versions of the Phillips curve: a typical New Keynesian Phillips curve with only forward looking dynamics and a hybrid New Keynesian Phillips curve with forward and backward looking dynamics. The main findings are as follows: (i) the backward looking dynamics (persistence) of inflation in the Phillips curve is an important determinant of the common economic policy in the monetary union; (ii) in the case of asymmetric dynamics of inflation in the monetary union countries, the country with more persistent inflation dynamics has a significant impact on the common economic policy.