Regional Inflation
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Regional Inflation indicates the ability of a region to participate in the currency union, for impacting its inflation differential with regard to the union. This impact, however, can be created through implementation of fiscal policy. In fact, Regional Inflation can be well-understood if one carefully notices the inter-relations between the inflation differentials and the regional fiscal policy in a two-region flexible price model, with respect to both traded and non-traded commodities.
In case of the symmetric regions, changes in the tax rule of the region reduces the fluctuations occurring in the inflation differential and that of its outputs simultaneously. In fact, it is the unpredictable nature of the tax rates, which reduces the fluctuating tendencies of inflation differential. With respect to tax rule on the fluctuations in output, it is based on the total size of the country concerned. For small countries, the fluctuations in the inflation differential is comparatively low, and it associates itself with the high volatility of output. This relationship is born out of the fact that countries smaller in size are more open in nature, undergoing traded goods productivity shocks at greater extents.
According to the above-stated model, Inflation or Price Differential across a particular country results from the movements in the comparative prices of its non-traded commodities, as well as legal deviations about the prices of traded commodities. Owing to the external stream of government expenses, this model has largely affected both productivities and expenditures on government level.
In a way, Regional Inflation facilitates the countries participating in the currency union to assign monetary policies to a central authorizing power. It is this monetary policy which act as the main tool for regulating the rate of inflation. Fluctuations in the rate of inflation arises because the countries constituting the currency union are not perfectly unified and uniform regions. Still, the Domestic Inflation rates continue to play significant role in reflecting the economic conditions of the country.
