Paper #958

Title:

The persistence of inflation in OECD countries: A fractionally integrated approach

Author:

Laura Mayoral

Date:

February 2005 (Revised: October 2005)

Abstract:

The statistical properties of inflation and, in particular, its degree of persistence and stability over time is a subject of intense debate and no consensus has been achieved yet. The goal of this paper is to analyze this controversy using a general approach, with the aim of providing a plausible explanation for the existing contradictory results. We consider the inflation rates of 21 OECD countries which are modelled as fractionally integrated (FI) processes. First, we show analytically that FI can appear in inflation rates after aggregating individual prices from firms that face different costs of adjusting their prices. Then, we provide robust empirical evidence supporting the FI hypothesis using both classical and Bayesian techniques. Next, we estimate impulse response functions and other scalar measures of persistence, achieving an accurate picture of this property and its variation across countries. It is shown that the application of some popular tools for measuring persistence, such as the sum of the AR coefficients, could lead to erroneous conclusions if fractional integration is present. Finally, we explore the existence of changes in inflation inertia using a novel approach. We conclude that the persistence of inflation is very high (although non-permanent) in most post-industrial countries and that it has remained basically unchanged over the last four decades.

Keywords:

Inflation persistence, persistence stability, ARFIMA models, long memory, structural breaks, bayesian estimations

JEL codes:

C22, E31

Area of Research:

Operations Management

Published in:

International Journal of Central Banking, nº 4, 2006

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