The Role of Inflation Persistence in the Inflation Process in the New EU Member States

Abstract

The aim of this paper is to compare inflation persistence between the New Member States (NMS) that joined the European Union in 2004 and 2007 and selected euro area members. If the levels of inflation persistence between the two groups are different, the NMS may encounter problems with fulfilling the Maastricht criterion on inflation and – after entering the euro area – with inflation divergence. We argue that the specific economic situation of the NMS in the last 15 years necessitates careful selection of inflation persistence measures. Two measures are estimated. The first one is based on a simple univariate statistical model of inflation with a time-varying mean. The second one assumes that inflation follows a fractionally integrated process and measures inflation persistence within an ARFIMA model. Statistical tests suggest that the model with a time-varying mean is preferable to the ARFIMA model for almost all countries. The estimation results show that inflation persistence is not an issue for all of the NMS. On the one hand, Bulgaria, Cyprus, the Czech Republic, Malta, Romania, and Slovakia exhibit persistence levels similar to those in the selected euro area countries. On the other hand, Estonia, Hungary, Latvia, Lithuania, Poland, and Slovenia encounter a problem with high persistence stemming from both high intrinsic and high expectations-based inflation persistence.inflation persistence, new member states, time-varying mean, central bank credibility, ARFIMA model, Bayesian estimation, Kalman filter