Evidence from the European Union on Testing the Kumara Swamy Theorem of Inflationary Gap

Abstract

This paper empirically tests the Kumara Swamy Theorem of the Inflationary Gap for 27 European Union countries over the period 1999-2011. The study obtained data from the World Bank’s World Development Indicators database for each country’s money supply, Gross National Income (GNI) and Consumer Price Index (CPI), as well as the Bank of England for the United Kingdom and the comparable agencies in Norway and Sweden. Results were compared to the seminal works of Swamy (1982) and (2009) that tested the theorem on the Nigerian economy, as well as recent studies by Lazaridis and Livanis (2010) for the Cypriot and Greek economies, Bauer and Faseruk (2012) for the Canadian economy and Faseruk, Bauer and Glew (2012) for the countries in the North American Free Trade Agreement. In the current study, the Kumara Swamy Theorem of the Inflationary Gap has provided notable explanatory power for the relationship between the growth of the money supply and real GNP in terms of direction but not necessarily in terms of magnitude. In order to explain differences, this paper examines subdivided samples for various sub-groupings, such as Portugal, Ireland, Italy, Greece and Spain, as well as former COMECON countries. This paper agrees with the insight from Faseruk, Bauer and Glew (2012) that the theorem is best understood as a long-term average and to disregard short-term fluctuations. Graphical evidence demonstrates when short-term fluctuations in the inflationary gap occurred and provides various explanations based on market data.

Keywords: Inflationary gap, European Union, Kumara Swamy Theorem

JEL Classification: C82, E31, E52, E58