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Inflation Convergence and Divergence within the European Monetary Union

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  • Fabio Busetti

    (Research Department, Bank of Italy)

  • Lorenzo Forni

    (Research Department, Bank of Italy)

  • Andrew Harvey

    (Faculty of Economics, Cambridge University)

  • Fabrizio Venditti

    (Research Department, Bank of Italy)

Abstract

We study the convergence properties of inflation rates among the countries of the European Monetary Union over the period 1980-2004. Given the Maastricht agreements and the adoption of the single currency, the sample can be naturally split into two parts, before and after the birth of the euro. We study convergence in the first subsample by means of unit-root tests on inflation differentials, arguing that for testing absolute convergence, a power gain is achieved if the Dickey-Fuller regressions are run without an intercept term. We find evidence for the convergence hypothesis over the period 1980-97 and a clear indication of the important role played by the Exchange Rate Mechanism (ERM) in strengthening the convergence process. We then investigate whether the second subsample is characterized by stable inflation rates across the European countries. Using stationarity tests on inflation differentials, we find evidence of diverging behavior. In particular, we can statistically detect two separate clusters, or stability clubs: (i) a lower-inflation group that comprises Germany, France, Belgium, Austria, and Finland and (ii) a higher-inflation one with Spain, the Netherlands, Greece, Portugal, and Ireland. Italy appears to form a cluster of its own, standing between the other two.

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Bibliographic Info

Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 3 (2007)
Issue (Month): 2 (June)
Pages: 95-121

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Handle: RePEc:ijc:ijcjou:y:2007:q:2:a:4

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  1. Steven N. Durlauf & Danny T. Quah, 1998. "The New Empirics of Economic Growth," Working Papers 98-01-012, Santa Fe Institute.
  2. Weber, Axel A. & Beck, Guenter, 2003. "How wide are European borders? On the integration effects of monetary unions," CFS Working Paper Series 2001/07, Center for Financial Studies (CFS).
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