Euro Area Inflation : Long-Run Determinants and Short-Run Dynamics

This study adopts the long-run structural VAR approach to analyse the determinants of inflation in the Euro Area economy over the period 1985:1-2003:2. Theoretical relationships link inflation to markup and output gap, respectively. The short-run dynamic properties of inflation are investigated using a structural VECM. Inflation is explained by a mixture of supply- and demand-side factors, both in the long- and the short-run. Our simulation exercise indicates that a positive shock to inflation could have a favourable re-distributional income effect on workers and non-detrimental consequences either on productivity and on competitiveness. Finally, the model produces satisfactory out-of-sample forecasts