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Stochastic Convergence in the Euro Area

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  • Giorgio Canarella

    (California State University, Los Angeles, and University of Nevada, Las Vegas)

  • Stephen M. Miller

    (University of Connecticut and University of Nevada, Las Vegas)

  • Stephen K. Pollard

    (California State University, Los Angeles)

Abstract

We investigate the dynamics of stochastic convergence of the original Euro Area countries for inflation rates, nominal interest rates, and real interest rates. We test for convergence relative to Germany, taken as the benchmark for core EU standards, using monthly data over the period January 2001 to September 2010. We examine, in a time-series framework, three different profiles of the convergence process: linear convergence, nonlinear convergence, and linear segmented convergence. Our findings both contradict and support convergence. Stochastic convergence implies the rejection of a unit root in the inflation rate, nominal interest rate, and real interest rate differentials. We find that the differentials are consistent with a unit-root hypothesis when the alternative hypothesis is I(0) with a linear trend. But we frequently, but not always, reject the unit-root hypothesis when the alternative is I(0) with a broken trend. We also note that the current financial crisis plays a significant role in dating the breaks.

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Bibliographic Info

Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2010-32.

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Date of creation: Dec 2010
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Publication status: Published in International Advances in Economic Research, August 2011
Handle: RePEc:uct:uconnp:2010-32

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Keywords: Stochastic convergence; Nonlinearity; Unit-root tests; Structural breaks.;

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