The Balassa-Samuelson Effect in Central Europe: A Disaggregated Analysis

Abstract

This paper aims to explain differences in inflation between six central European economies - Croatia, the Czech Republic, Hungary, Poland, Slovakia and Slovenia - and the euro area in terms of differences in productivity growth between tradable and non-tradable sectors. The coverage of tradable and non-tradable sectors is broader and more detailed than in previous studies and the data samples are larger, as quarterly data for up to 10 years are used. The main conclusion is that productivity differentials explain on average only between 0.2 and 2.0 percentage points of annual inflation differentials vis-a-vis the euro area. Productivity differentials also explain only a small proportion of domestic inflation in central European economies. Earlier studies that estimated the Balassa-Samuelson effect to be larger have often neglected to consider the impact of productivity differentials on inflation relative to the euro area, focusing instead only on their impact on domestic inflation. Many studies have also neglected the relatively high productivity growth in non-tradable industries. The estimates in this paper suggest that differences in productivity growth between EU accession countries and the euro area are unlikely to widen sufficiently to become a determining factor in the ability of these countries to satisfy the Maastricht inflation criterion.