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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.

Suggested Citation

  • Thams, Andreas, 2007. "Inflation Transmission in the EMU: A Markov-Switching VECM Analysis," MPRA Paper 1643, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:1643
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    File URL: https://mpra.ub.uni-muenchen.de/1643/1/MPRA_paper_1643.pdf
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    References listed on IDEAS

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    3. 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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    5. Nicoletta Batini, 2006. "Euro area inflation persistence," Empirical Economics, Springer, vol. 31(4), pages 977-1002, November.
    6. 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.
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    Cited by:

    1. Muhammad Imtiaz Subhani & Syed Akif Hasan & Amber Osman & Junaid Minhas, 2013. "Are the inflations of world co-integrated?," South Asian Journal of Management Sciences (SAJMS), Iqra University, Iqra University, vol. 7(1), pages 9-18, Spring.
    2. 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.

    More about this item

    Keywords

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

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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