We study the determinants of inflation differentials in the euro area by decomposing the overall variability of inflation rates across countries into a common component and two idiosyncratic components, which respectively depend on the dynamics of unit labour costs (ULC) and the markups specific to each country.
The contribution of idiosyncratic (country-specific) developments in ULC is particularly relevant for the euro area; the contribution of the common component is instead contained, contrary to the estimates for the United States. When two subgroups of euro-area countries are considered, namely core and non-core countries, it is found that the role of the subgroup-specific common component becomes more important, suggesting a relatively higher homogeneity across the labour and product markets within these two subgroups.
