Studying inflation differentials using a DSGE approach: The case of Greece

This paper attempts to identify the main contributing factors of Greece's inflation differentials for the 2000-2010 period. In particular, the purpose of this study is to assert whether these differentials were due to a "catching-up" effect or to structural differences of Greece's economy when compared to that of the the rest of the Euro Area. In this context, a Dynamic Stochastic General Equilibrium model is utilized to evaluate how symmetric shocks have diverse effects resulting in a divergence of inflation rates. The main results indicate that inflation differentials were driven by technology shocks in the tradable sector, and to a lesser extent by the Balassa-Samuelson effect. Therefore, the inflation differentials of Greece were mainly due to factors unrelated to the high economic growth the country experienced during this period. The main conclusion from the analysis is that inflation differentials do have negative effects on Greece's the real economy and that they can be reduced only through the implementation of structural changes.