A markup model of inflation for the euro area

Abstract

Equilibrium correction models of the price level are often used to model inflation. Such models assume that the long-run markup of prices over costs is fixed, but this may not be true for the Euro area economy, which has undergone major structural reforms over the last 25 years. We allow for shifts in the markup factor through estimating an equation that includes a timevarying intercept. The model fits the data better than a linear alternative, and suggests that a reduction in the price-cost markup contributed to disinflation in the Euro area during the 1980s. JEL Classification: C22,C32,E31cointegration, dynamic modelling, inflation, price-cost markup, time-varying intercept