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Inflation Transmission in the EMU: A Markov-Switching VECM Analysis

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  • Thams, Andreas

Abstract

This paper analyzes the transmission of inflation across the five largest economies in the European Monetary Union, i.e. France, Germany, Italy, Netherlands and Spain. We use monthly CPI inflation rates for the period 1970-2006. Given the long observation period and the continuing economic integration of Europe’s economies, we first try to investigate, if there were changes in inflation dynamics in these countries using univariate Markov-switching models. To assess the inflation transmission mechanism, we first establish a long-run relationship between the five countries using cointegration methods. As implied by the results of the univariate models, we allow for changes in the adjustment coefficients of the cointegrating relationships and the short-run dynamics. Using a Markov-switching vector error correction model we find evidence for multiple regime switches during the early 1970s till the mid 1980s. Exactly during this period we find evidence for Germany being weakly exogenous, which highlights the dominance of German monetary policy at this time. Since the mid-1980s we find evidence for a stable transmission mechanism both in the long- and the short-run characterized by a low degree of inflation persistence.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 1643.

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Date of creation: Nov 2007
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Handle: RePEc:pra:mprapa:1643

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Keywords: Inflation transmission; monetary integration; MS-VECM; cointegration; euro area;

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  1. Eun, Cheol S. & Jeong, Jin-Gil, 1999. "International price level linkages: Evidence from the post-Bretton Woods era," Pacific-Basin Finance Journal, Elsevier, vol. 7(3-4), pages 331-349, August.
  2. Johansen, Soren, 1995. "Likelihood-Based Inference in Cointegrated Vector Autoregressive Models," OUP Catalogue, Oxford University Press, number 9780198774501, September.
  3. Darby, Michael R. & Lothian, James R. & Gandolfi, Arthur E. & Schwartz, Anna J., 1983. "The International Transmission of Inflation," National Bureau of Economic Research Books, University of Chicago Press, edition 0, number 9780226136417.
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  7. Michael R. Darby & James Lothian, 1989. "The International Transmission of Inflation Afloat," NBER Chapters, in: Money, History, and International Finance: Essays in Honor of Anna J. Schwartz, pages 203-244 National Bureau of Economic Research, Inc.
  8. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  9. Levin, Andrew T. & Piger, Jeremy M., 2004. "Is inflation persistence intrinsic in industrial economies?," Working Paper Series 0334, European Central Bank.
  10. Yang, Jian & Guo, Hui & Wang, Zijun, 2006. "International transmission of inflation among G-7 countries: A data-determined VAR analysis," Journal of Banking & Finance, Elsevier, vol. 30(10), pages 2681-2700, October.
  11. Andrews, Donald W K & Chen, Hong-Yuan, 1994. "Approximately Median-Unbiased Estimation of Autoregressive Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(2), pages 187-204, April.
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  13. Filippo Altissimo & Michael Ehrmann & Frank Smets, 2006. "Inflation persistence and price-setting behaviour in the euro area – a summary of the IPN evidence," Occasional Paper Series 46, European Central Bank.
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Cited by:
  1. Mihalicova, Xenia & Gazda, Vladimír & Kubak, Matúš & Grof, Marek, 2011. "P-Star Model under the Currency Board – The Case of Bulgaria 1997-2008," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(3), pages 83-91, September.

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