Inflation Convergence and Divergence within the European Monetary Union

38 Pages Posted: 17 Jan 2006

See all articles by Fabio Busetti

Fabio Busetti

Bank of Italy

Lorenzo Forni

International Monetary Fund (IMF)

Andrew Harvey

University of Cambridge - Department of Applied Economics

Fabrizio Venditti

Bank of Italy

Date Written: January 2006

Abstract

We study the convergence properties of inflation rates among the countries of the European Monetary Union over the period 1980-2004. Given the Maastricht agreements and the adoption of the single currency, the sample can be naturally split into two parts, before and after the birth of the euro. We study convergence in the first sub-sample by means of univariate and multivariate unit root tests on inflation differentials, arguing that the power of the tests is considerably increased if the Dickey-Fuller regressions are run without an intercept term. Over-all, we are able to accept the convergence hypothesis over the period 1980-1997. We then investigate whether the second sub-sample is characterized by stable inflation rates across the European countries. Using stationarity tests on inflation differentials, we find evidence of diverging behaviour. In particular, we can statistically detect two separate clusters, or convergence clubs: a lower inflation group that comprises Germany, France, Belgium, Austria, Finland and a higher inflation one with Spain, Netherlands, Greece, Portugal and Ireland. Italy appears to form a cluster of its own, standing in between the other two.

Keywords: Absolute Convergence, Inflation Differentials, Stability, Unit Root Tests

JEL Classification: C12, C22, C32, E31

Suggested Citation

Busetti, Fabio and Forni, Lorenzo and Harvey, Andrew and Venditti, Fabrizio, Inflation Convergence and Divergence within the European Monetary Union (January 2006). ECB Working Paper No. 574. Available at SSRN: https://ssrn.com/abstract=872684

Fabio Busetti (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy
39 06 479 23245 (Phone)
39 06 474 7820 (Fax)

Lorenzo Forni

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Andrew Harvey

University of Cambridge - Department of Applied Economics ( email )

Sidgwick Avenue
Cambridge, CB3 9DE
United Kingdom
+44 1223 335 228 (Phone)
+44 1223 335 475 (Fax)

Fabrizio Venditti

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy

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