Ann Reg Sci (2008) 42:945–966 DOI 10.1007/s00168-007-0196-5 ORIGINAL PAPER Regional productivity and relative prices dynamics: the case of Italy Carla Massidda · Paolo Mattana Received: 16 January 2006 / Accepted: 15 June 2007 / Published online: 18 December 2007 © Springer-Verlag 2007 Abstract In this paper, we study the cointegrating space spanned by Italian regional relative prices and per capita GDPs. To this end, we combine panel data with vec- tor error correction model estimation in an innovative approach which is still under development. The results are interesting: regional prices, which seem to persistently deviate from the law of one price (PPP), cointegrate with relative per capita GDPs. The estimated elasticity is not consistent with the Balassa–Samuelson hypothesis but is closer to supporting the classical supply-demand schedule. Weak-causality testing gives further details on linkages between the real and nominal side of Italy’s regionally diversified economy. Homogeneity of the coefficients, lacking at a national level, can be recovered at a more disaggregated macro-area level. JEL Classification C33 · E31 1 Introduction Starting with the so-called collapse of the PPP in post Bretton–Woods data, 1 many authors have studied the relevance of real factors in determining permanent misali- gnments of real exchange rate with respect to the equilibrium condition. The most frequently quoted explanation is the Balassa–Samuelson effect (BSE) which suggests a positive correlation between real exchange rates and relative growth performance. 2 Work on the relevance of the BSE has recently been extended to countries sharing a common currency, where spurious influences on the rate of price convergence, such 1 For a recent survey on the issue, see Taylor and Taylor (2004). 2 The analytics of the BSE are exhaustively expounded in Obstfeld and Rogoff (1996). C. Massidda (B ) · P. Mattana Department of Economics, University of Cagliari, Viale S. Ignazio, 17, 09123 Cagliari, Italy e-mail: massidda@unica.it 123