Are euro area inflation rates misaligned?

Lopez, Claude and Papell, David (2010): Are euro area inflation rates misaligned?

Abstract

We study the behavior of inflation rates among Euro countries. More specifically, we are interested in testing whether and when group convergence dictated by the Maastricht treaty occurs, and we assess the impact of events such as the advent of the Euro and the 2008 financial crisis. Due to the small size of the estimation sample, we propose a new procedure that increases the power of panel unit root tests when used to study group-wise convergence. Applying this new procedure to Euro Area inflation, we find strong and lasting evidence of convergence among the inflation rates soon after the implementation of the Maastricht treaty and a dramatic decrease in the persistence of the differential after the occurrence of the single currency. Furthermore, while we find divergence among some of the Euro countries prior to the 2008 financial crisis, the convergence is strengthened after the crisis for all countries except Greece.

• Item Type: MPRA Paper
• Language: English
• Keywords: groupwise convergence, inflation, euro, 2008 crisis
• Subjects: C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation

References

Andrews, D. W. K., and H-Y. Chen, 1994, Approximately Median-Unbiased Estimation of Autoregressive Models, Journal of Business & Economic Statistics, 12 (2): 187-204.

Bai, J. and S. Ng, 2004, A PANIC Attack on Unit Roots and Cointegration, Econometrica, 72: 1127-1177.

Ben-David, D., 1993, Equalizing Exchange: Trade Liberalization and Income Convergence, Quarterly Journal of Economics, 108(3): 653-79.

Ben-David, D., 1996, Trade and convergence among countries, Journal of International Economics, 40(3-4): 279-298.

Bernard, A. B. and S.N. Durlauf, 1995, Convergence in international output, Journal of Applied Econometric, 10: 97-108.

Bernard, A. B. and S.N. Durlauf, 1996, Interpreting tests of the convergence hypothesis, Journal of Econometrics, 71: 161-174.

Breitung, J. and M. H., Peseran, 2005, Unit Roots and Cointegration in Panels, L. Matyas and P. Sevestre (eds), The Econometrics of Panel Data: Fundamentals and Recent Developments in Theory and Practice.

Breuer, J., R. Robert and M. Wallace, 2001, Misleading Inferences from Panel Unit-Root Tests with an Illustration from Purchasing Power Parity, Review of International Economics, 9(3): 482-93.

Breuer, J., R. McNown and M. Wallace, 2002, Series-Specific Unit Root Tests with Panel Data, Oxford Bulletin of Economics and Statistics, 64(5):527-46.

Busetti F., L. Forni, A. Harvey and F. Venditti, 2007, Inflation Convergence and Divergence within the European Monetary Union, International Journal of Central Banking, International Journal of Central Banking, 3(2): 95-121.

Chang, Y. 2004, Bootstrap Unit Root Tests in Panels with Cross-sectional Dependency, Journal of Econometrics, 120: 263-293.

Davidson, R., and J.G MacKinnon, 1999, The Size Distortion Of Bootstrap Tests. Econometric Theory, 15:361-376.

Davidson, R. and J.G. MacKinnon, 2006, Bootstrap methods in econometrics, Palgrave Handbooks of Econometrics: Volume 1 Econometric Theory, 812-838.

Durlauf, S. and Quah, 1999, The new empirics of economic growth, Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, ed.1, 1 (4): 235-308.

European Central Bank, 2003, Inflation differentials in the euro area: potential causes and policy implications Engel, C. and J. Rogers, 2004, European Market Integration After the Euro, Economic Policy, 19: 347-384.

Evans, P. and G. Karras, 1996, Do Economies Converge? Evidence from a Panel of U.S. States, The Review of Economics and Statistics, 78(3): 384-88.

Evans, P. 1998, Using Panel Data to Evaluate Growth Theories, International Economic Review, 39(2): 295-306.

Fleissig, A.R. and J. Strauss, 2001. Panel unit-root tests of OECD stochastic convergence, Review of International Economics, 9: 153–162.

Fritsche, U. and V. Kuzin, 2008, Analyzing Convergence in Europe Using a Non-linear Single Factor Model, Macroeconomics and Finance Series, Hamburg University. Greene, W.H, 2008, Econometric Analysis, Pearson Hall, 6th edition.

Hall, A., 1994, Testing for a Unit Root in Time Series with Pretest Data-Based Model Selection, Journal of Business and Economic Statistics, 12:461-470.

Honohan, P. and P.R Lane, 2003, Divergent inflation rates in EMU, Economic Policy, 12 (37): 357-394.

Honohan, P. and P.R Lane, 2004, Exchange Rates and Inflation Under EMU: An Update, CEPR Discussion Papers 4583.

Im, K.S., M.H. Pesaran, and Y., Shin, 2003, Testing for Unit Roots in Heterogeneous Panels, Journal of Econometrics, 115(1): 53-74.

Islam, N., 1995, Growth Empirics: A Panel Data Approach, Quarterly Journal of Economics, 110(4): 1127-70.

Judge, G.G., Hill, R.C., Griffiths, W., Lütkepohl, H. and T. Lee, 1988, Introduction to the Theory and Practice of Econometrics, Wiley, 2nd edition.

Kočenda, E. and D.H. Papell, 1997. Inflation Convergence Within the European Union: A Panel Data Analysis, International Journal of Finance and Economics, 2(3): 189-198.

Lee, H. Y. and J. L. Wu, 2001, Mean Reversion of Inflation Rates: Evidence from 13 OECD Countries, Journal of Macroeconomics, 23: 477-487.

Levin, A., C.F. Lin, and C.J. Chu, 2002, Unit Root Tests in Panel Data: Asymptotic and Finite-Sample Properties, Journal of Econometrics, 108: 1-24.

Lopez, C, 2009a, Panel Unit Root with Good Power in Small Samples, Econometric Reviews, 28 (4): 295-313

Lopez, C, 2009b, Euro-zone Inflation Rates: Stationary or Regime-wise Stationary Processes, Economics Bulletin, 29(1): 238-243

Maddala, G.S. and S. WU, 1999, A comparative Study of Unit Root Tests with Panel Data and a New Simple Test, Oxford Bulletin of Economics and Statistics, 61: 631-652.

Murray, C.J., and D.H. Papell, 2005, Do Panels Help Solve the Purchasing Power Parity Puzzle?, 2005, Journal of Business and Economic Statistics, 23: 410-415.

O'Connell P., 1998, The Overvaluation of Purchasing Power Parity, Journal of International Economics, 44: 1-19.

Papell, D.H., 1997, Searching for Stationarity: Purchasing Power Parity under the Current Float, Journal of International Economics, 43: 313-332.

Pesaran, M.H, 2007, A pair-wise approach to testing for output and growth convergence, Journal of Econometrics, 138(1): 312-355.

Rogers, J.H., 2007, Monetary Union, Price Level Convergence, and Inflation: How Close is Europe to the USA?, Journal of Monetary Economics, 54 (3): 785-796.

Rogers, J.H., Hufbauer, G., Wada, E., 2001. Price level convergence and inflation in Europe, Institute for International Economics, WP 01-1.

Sarno, L. and M.P. Taylor, 2002, Purchasing Power Parity and the Real Exchange Rate, International Monetary Fund Staff Papers, 49(1), 65-105.

Taylor, M.P, and L. Sarno, 1998, The behavior of real exchange rates during the post-Bretton Woods period, Journal of International Economics, 46 (2): 281-312.

Taylor, A.M. and M.P. Taylor, 2004, The Purchasing Power Parity Debate, Journal of Economic Perspectives, 18(4):135-158.

Weber A.A and G.W. Beck, 2005, Price Stability, Inflation Convergence and Diversity in EMU: Does One Size Fit All?, CFS WP 2005/30.