Divergent Inflatin in Euroland : A Phillips Curve approach to the EMU-12

Abstract: This thesis investigates the cause and implications of the divergent inflationrates of the EMU-12 countries between the years 1998 and 2010. The EMUand the euro are put into a context with the classic theory of Optimum CurrencyArea, where the economic benefits and cost of joining a monetary unionis reviewed. The inflation divergence in the euro area is then described and investigated.Empirically, a Phillips Curve model is constructed in order to determineif the EMU-12 nations’ inflation rates are equally sensitive to changesin unemployment as the EMU average. This is done using a Panel Least Squareestimation for the EMU-12. Each nation is then tested separately against theEMU average. The result provides evidence that the EMU-12 nations’ inflationrates are not equally sensitive to changes in unemployment as the EMU average.The result is negative for the EMU-12 in an Optimum Currency Area context.Given the results, the EMU-12 cannot be considered to be an OptimumCurrency Area, at least not yet.