On the Relevance and Nature of Regional Inflation Differentials: The Case of Spain

Abstract

This paper studies two aspects of the behaviour of provincial relative prices in Spain: the relevance and the nature of provincial inflation divergences and relative price shifts. Inflation differentials are found to be small (the range is less than half point per year in the long-run), but deviations of relative prices from equilibrium can be very persistent. Relative price shifts turn out to be determined by characteristics which are intrinsic to very deep economic integration, in particular, price and wage mechanisms which operate at the national level. This is in stark contrast to evidence on the determinants of real exchange rates among countries; as a consequence, the Balassa-Samuelson hypothesis results clearly rejected. Therefore, while admiting that inflation differentials among EMU participants are possible, their nature will be different from those existing among Spanish provinces.