Convergences of Prices and Rates of Inflation

39 Pages Posted: 10 Apr 2006

See all articles by Fabio Busetti

Fabio Busetti

Bank of Italy

Silvia Fabiani

Bank of Italy

Andrew Harvey

University of Cambridge - Department of Applied Economics

Date Written: February 2006

Abstract

We consider how unit root and stationarity tests can be used to study the convergence properties of prices and rates of inflation. Special attention is paid to the issue of whether a mean should be extracted in carrying out unit root and stationarity tests and whether there is an advantage to adopting a new (Dickey-Fuller) unit root test based on deviations from the last observation. The asymptotic distribution of the new 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 case of primary interest for analysing convergence. We argue that the joint use of unit root and stationarity 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. The tests are applied to the monthly series of the Consumer Price Index in the Italian regional capitals over the period 1970-2003. It is found that all pairwise contrasts of inflation rates have converged or are in the process of converging. Only 24% of price level contrasts appear to be converging, but a multivariate test provides strong evidence of overall convergence.

Keywords: Dickey-Fuller test, initial condition, law of one price, stationarity test

JEL Classification: C22, C32

Suggested Citation

Busetti, Fabio and Fabiani, Silvia and Harvey, Andrew, Convergences of Prices and Rates of Inflation (February 2006). Bank of Italy Economic Research Paper No. 575. Available at SSRN: https://ssrn.com/abstract=895512 or http://dx.doi.org/10.2139/ssrn.895512

Fabio Busetti (Contact Author)

Bank of Italy ( email )

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

Silvia Fabiani

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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)

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
84
Abstract Views
808
rank
311,500
PlumX Metrics