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Inflation Convergence and Divergence within the European Monetary Union

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Author Info
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)

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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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Publisher 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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Find related papers by JEL classification:
C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Hypothesis Testing
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

References listed on IDEAS
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  11. Flores, Renato & Jorion, Philippe & Preumont, Pierre-Yves & Szafarz, Ariane, 1999. "Multivariate unit root tests of the PPP hypothesis," Journal of Empirical Finance, Elsevier, vol. 6(4), pages 335-353, October. [Downloadable!] (restricted)
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  12. Harvey, A. & Bates, D., 2003. "Multivariate Unit Root Tests and Testing for Convergence," Cambridge Working Papers in Economics 0301, Faculty of Economics, University of Cambridge. [Downloadable!]
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  15. Im, Kyung So & Pesaran, M. Hashem & Shin, Yongcheol, 2003. "Testing for unit roots in heterogeneous panels," Journal of Econometrics, Elsevier, vol. 115(1), pages 53-74, July. [Downloadable!] (restricted)
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  16. Kwiatkowski, Denis & Phillips, Peter C. B. & Schmidt, Peter & Shin, Yongcheol, 1992. "Testing the null hypothesis of stationarity against the alternative of a unit root : How sure are we that economic time series have a unit root?," Journal of Econometrics, Elsevier, vol. 54(1-3), pages 159-178. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Sebastian Dullien & Ulrich Fritsche, 2007. "Does the Dispersion of Unit Labor Cost Dynamics in the EMU Imply Long-Run Divergence?: Results from a Comparison with the United States of America and Germany," Discussion Papers of DIW Berlin 674, DIW Berlin, German Institute for Economic Research. [Downloadable!]
    Other versions:
  2. GRENADE, Kari & MOORE, Winston, 2008. "Co-Movements Between Foreign And Domestic Interest Rates In A Fixed Exchange Rate Regime: The Case Of The Eccu And The Us," Applied Econometrics and International Development, Euro-American Association of Economic Development, vol. 8(1), pages 119-130. [Downloadable!] (restricted)
  3. Fabio Busetti & Andrew Harvey, 2007. "Testing for trend," Temi di discussione (Economic working papers) 614, Bank of Italy, Economic Research Department. [Downloadable!]
    Other versions:
  4. Massimiliano Affinito & Fabio Farabullini, 2006. "An empirical analysis of national differences in the retail bank interest rates of the euro area," Temi di discussione (Economic working papers) 589, Bank of Italy, Economic Research Department. [Downloadable!]
  5. Peter Bofinger & Eric Mayer, 2007. "Monetary and Fiscal Policy Interaction in the Euro Area with Different Assumptions on the Phillips Curve," Open Economies Review, Springer, vol. 18(3), pages 291-305, July. [Downloadable!] (restricted)
  6. Guglielmo Maria Caporale & Alexandros Kontonikas, 2006. "The Euro and Inflation Uncertainty in the European Monetary Union," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
  7. Alina M. Spiru, 2008. "Inflation Convergence In Central And Eastern European Economies," Romanian Economic Business Review, Romanian-American University, vol. 3(4), pages 14-34, Winter. [Downloadable!]
  8. Alberto Montagnoli & Andros Gregoriou & Alexandros Kontonikas, 2007. "Euro Area Inflation Differentials: Unit Roots, Structural Breaks and Non-Linear Adjustment," Working Papers 2007_13, Department of Economics, University of Glasgow. [Downloadable!]
  9. P. Siklos & M. Bohl, 2006. "Asset Prices as Indicators of Euro Area Monetary Policy: An Empirical Assessment of Their Role in a Taylor Rule," Working Papers eg0053, Wilfrid Laurier University, Department of Economics, revised 2006. [Downloadable!]
    Other versions:
  10. Yilmazkuday, Hakan, 2009. "Inflation Targeting and Inflation Convergence within Turkey," MPRA Paper 16770, University Library of Munich, Germany. [Downloadable!]
  11. Agnes Benassy-Quere, 2006. "Short-Term Fiscal Spillovers in a Monetary Union," Working Papers 2006-13, CEPII research center. [Downloadable!]
  12. Constantina Kottaridi & Diego Mendez-Carbajo & Dimitrios Thomakos, 2007. "Inflation Dynamics and the Cross-Sectional Distribution of Prices in the E.U. Periphery," Working Papers 0004, University of Peloponnese, Department of Economics. [Downloadable!]
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  13. Ashoka Mody & Franziska Ohnsorge, 2007. "Can Domestic Policies Influence Inflation?," IMF Working Papers 07/257, International Monetary Fund. [Downloadable!]
  14. Alina Spiru, 2007. "Inflation convergence in the new EU member states," Working Papers 005221, Lancaster University Management School, Economics Department. [Downloadable!]
  15. Pelinescu, Elena & Caraiani, Petre, 2006. "Does the Inflation Targeting Have a Positive Role upon the Convergence of the Inflation Rate?," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 3(3), pages 39-50, September. [Downloadable!]
  16. Andrea, SILVESTRINI, 2007. "Testing fiscal sustainability in Poland : a Bayesian analysis of cointegration," Discussion Papers (ECON - Département des Sciences Economiques) 2007040, Université catholique de Louvain, Département des Sciences Economiques. [Downloadable!]
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  17. Christian Proaño Acosta, 2007. "Inflation Differentials and Business Cycle Fluctuations in the European Monetary Union," IMK Working Paper 05-2007, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute. [Downloadable!]
  18. Claude Lopez, 2008. "Euro-zone Inflation Rates: Stationary or Regime-wise Stationary Processes," University of Cincinnati, Economics Working Papers Series 2008-02, University of Cincinnati, Department of Economics, revised 2008. [Downloadable!]
  19. Ulrich Fritsche & Vladimir Kuzin, 2007. "Unit Labor Cost Growth Differentials in the Euro Area, Germany, and the US: Lessons from PANIC and Cluster Analysis," Discussion Papers of DIW Berlin 667, DIW Berlin, German Institute for Economic Research. [Downloadable!]
    Other versions:
  20. Giulio Palomba & Emma Sarno & Alberto Zazzaro, 2009. "Testing similarities of short-run inflation dynamics among EU-25 countries after the Euro," Empirical Economics, Springer, vol. 37(2), pages 231-270, October. [Downloadable!] (restricted)
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