Inflation convergence in Central and Eastern Europe vs. the Eurozone: Non‐linearities and long memory

Abstract

In this paper we consider inflation rate differentials between seven Central and Eastern European Countries (CEECs) and the Eurozone. We test for convergence in the inflation rate differentials, incorporating non-linearities in the autoregressive parameters, fractional integration with endogenous structural changes, and also consider club convergence analysis for the CEECs over the period 1997 to 2015 based on monthly data. Our empirical findings suggest that the majority of countries experience non-linearities in the inflation rate differential, however there is only evidence of a persistent difference in some countries. Complementary to this analysis we apply the Phillips and Sul (2007) test for club convergence and find that there is evidence that most of the CEECs converge to a common steady state.

Dynamics and factors of inflation convergence in the European union

“…The results in Cuestas et al (2016) imply that a certain degree of non-linearity in the series of inflation differentials should be considered when planning the adoption of the common currency in the prospective euro area members.…”

“…Also, two papers that consider modified ADF tests- Giannellis (2013) and Cuestas et al (2016)-find evidence against convergence. In our analysis, we attempt to reconcile the latest trends in the inflation convergence literature with a traditional approach: we employ the ADF-SUR test (Lopez and Papell, 2012) but allow for structural breaks in our specification (Kočenda et al, 2006;Cuestas et al, 2016). Moreover, to provide a richer set of results, we use two additional inflation benchmarks apart from the cross-sectional average: the Maastricht benchmark and the ECB target of "below, but close to, 2% over the medium term".…”

“…Next, Cuestas et al (2016) focus on the recent post-crisis years and a group of Central, Eastern and Southeastern European (CESEE) countries and (i) show that the GFC should be considered when estimating series of inflation differentials and (ii) find evidence of structural breaks and non-linear elements in inflation differentials. The results in Cuestas et al (2016) imply that a certain degree of non-linearity in the series of inflation differentials should be considered when planning the adoption of the common currency in the prospective euro area members.…”

“…Finally, a sizable portion of the literature, such as Kočenda et al (2006) or Cuestas et al (2016), studies the inflation convergence of prospective members of the euro area towards the current members. Importantly, these studies introduce structural breaks into the discussion on the topic of inflation convergence.…”

“…We refine the test with an addition of dummy variables and a linear time trend. Moreover, we control for structural breaks as in related research (Kočenda et al, 2006;Cuestas et al, 2016). The following specification with covariates is then jointly estimated in the seemingly unrelated regressions (SUR) framework for the 28 member states of the EU:…”