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Convergence of Prices and Rates of Inflation

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  • Fabio Busetti
  • Silvia Fabiani
  • Andrew Harvey

Abstract

We consider how unit‐root and stationarity tests can be used to study the convergence of prices and rates of inflation. We show how the joint use of these tests in levels and first differences allows the researcher to distinguish between series that are converging and series that have already converged, and we set out a strategy to establish whether convergence occurs in relative prices or just in rates of inflation. Special attention is paid to the issue of whether a mean should be extracted in carrying out tests in first differences and whether there is an advantage to adopting a (Dickey–Fuller) unit‐root test based on deviations from the last observation. The asymptotic distribution of this last test statistic is given and Monte Carlo simulation experiments show that the test yields considerable power gains for highly persistent autoregressive processes with ‘relatively large’ initial conditions. The tests are applied to the monthly series of the consumer price index in the Italian regional capitals over the period 1970–2003.

Suggested Citation

  • Fabio Busetti & Silvia Fabiani & Andrew Harvey, 2006. "Convergence of Prices and Rates of Inflation," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 68(s1), pages 863-877, December.
  • Handle: RePEc:bla:obuest:v:68:y:2006:i:s1:p:863-877
    DOI: 10.1111/j.1468-0084.2006.00460.x
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    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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