Beruflich Dokumente
Kultur Dokumente
Manmohan S. Kumar
International Monetary Fund
and
Tatsuyoshi Okimoto*
Associate Professor
Faculty of Economics and IGSSS,
Yokohama National University
We are indebted to James Hamilton for his guidance and Katsumi Shimotsu for helpful
discussion. We would also like to thank Takeo Hoshi, Bruce Lehmann, Masahito
Kobayashi, Laura Kodres, Keiji Nagai, Raghu Rajan, Ken Rogoff, Yixiao Sun, Masahiko
Takeda, Allan Timmermann, Kenichi Ueda, and seminar participants at the IMF, the
Yokohama National University and the University of Tokyo for discussions and comments.
Abstract
Characteristics of inflation play a key role in policy formulation and market
analysis. Several studies have analyzed inflation persistence and reached diverging
conclusions. In this paper we investigate the dynamics of inflation persistence using
fractionally integrated processes and find that there has been a clear decline in inflation
persistence in the U.S. over the past two decades. We also show that the presence of
fractional integration in inflation successfully explains previous diverging results. Lastly
we provide some international comparisons to examine the extent to which there has been a
commensurate decline in inflation persistence in the other G7 economies.
Introduction
In recent years, there has been an active debate regarding the extent to which
dynamics of the inflation process in the world economy, particularly in the largest countries,
have changed. The discussion has been especially intense regarding the extent to which
inflation persistence has declined. This issue is important from both an analytical and a
policy perspective, and it could be argued that changes in the degree of inflation persistence
may reflect economies changing resilience to shocks.
concerns abated somewhat as the effects of that crisis waned, but resurfaced in the
aftermath of the bursting of the equity price bubble in early 2000, geopolitical uncertainties
and the global slowdown.2 With the rebound in global activity since then, declining
measures of economic slack, and sharply higher oil and non-oil commodity prices, markets
and policymakers have again become preoccupied with inflation. Nonetheless, the
turnaround still leaves a key issue unresolved: the extent to which there has been a change
in the underlying characteristics of the inflation process, and its implications for policy
design and financial markets.
There have been a number of recent studies trying to empirically assess the
persistence of inflation, especially in the United States, but they appear to reach quite
diverging conclusions. These studies can be broadly divided into two methodological types,
depending on the measure of persistence. Studies in the first category rely on order of
integration as the measure of inflation persistence, using unit root tests to classify the
inflation process as either an I(0) or I(1) process. MacDonald and Murphy (1989) found
strong evidence for nonstationary I(1) behavior in the U.S. inflation from 1955 to 1986, and
Evans and Wachtel (1993) suggested that the monthly U.S. inflation rate seemed to be an
I(1) process during 1978 to 1992. On the other hand, Rose (1988) indicated that monthly
U.S. inflation was an I(0) process from 1947 to 1986. Mixed evidence was provided by
Brunner and Hess (1993). They concluded that the inflation rate was I(0) before the 1960s
but that it is characterized as I(1) since that time. Other studies include Barsky (1987), Ball
and Cecchetti (1990), Kim (1993), and Culver and Papell (1997).
The particular sample and subsample periods used differs across studies. When
one only looks at a few arbitrary subsamples, it is difficult to distinguish between a
permanent and temporary decline in inflation persistence. To our knowledge, there are only
a few studies that systematically document the changes over time in the dynamics of
inflation persistence. Cogley and Sargent (2001, 2005) estimated a Bayesian state-space
VAR model of inflation dynamics and provided a time series of inflation persistence in the
United States. They used the spectrum at frequency zero as the measure of inflation
persistence and indicated that there has been an unambiguous decline in inflation
persistence. Their finding was taken to mean that indeed there had been a change in the
underlying characteristics of inflation reflecting both a change in the structural
characteristics of the economy as well possibly in the efficacy and a greater forward
looking nature of monetary policy. In complete contrast, as a comment on Cogley and
Sargent (2001), Stock (2001) estimated the LARR using rolling window estimation method.
He suggested that there is no indication of a marked decline in the persistence. Following
these studies, Pivetta and Reis (2006) estimated the LARR and the SARC using both
Bayesian and rolling window estimation methods. Their main conclusion is that inflation
persistence in the United States has been high and approximately unchanged over the entire
post-war period.
One possible explanation for this debate and divergent results of unit root tests is
the presence of fractional integration in inflation rate,4 which is not consistent with either
an I(0) or an I(1) process. If fractional integration exists, it is possible for AR model-based
measures and unit root tests to reach diverging conclusions, as will be shown in this paper.
In fact, a number of studies find the presence of fractional integration in inflation rates. For
instance, Hassler and Wolters (1995) found that inflation is best characterized as the
fractional integral of white noise, while Baillie, Chung, and Tieslau (1996) suggested that
the ARFIMA-GARCH models best capture the dynamic properties of inflation in the major
industrial countries. Following those studies, Baum, Barkoulas, and Caglayan (1999)
estimated order of fractional integration using both CPI and WPI indices for a number of
industrial and developing countries. They conclude that inflation is best characterized as a
long memory process.5 See also Baillie, Han and Kwon (2002), Bos, Franses and Ooms
(1999, 2002).
The contributions of this paper are threefold. First, the paper provides new
evidence on the dynamics of inflation persistence. Specifically, we suggest using order of
fractional integration to measure inflation persistence, which can be considered as a
generalization of the first type of method that simply tries to choose between an I(0) or I(1)
representation. In addition, the method can also successfully provide an appropriate
measure of persistence related to the LAAR when there is fractional integration. As a
consequence, the method enables us to avoid possible confusion inherent in the second
methodology. We find clear evidence in the U.S. of a decline in inflation persistence since
the early 1980s. Second, the paper reconciles the diverging results of unit root tests and
AR model-based measures reported in previous studies. Third, we summarize the dynamics
of inflation persistence for other G7 countries, to examine the extent to which there has
been a commensurate decline in inflation persistence in other G7 countries. We find
remarkable similarities between the dynamics of inflation persistence in the U.S and other
G7 countries, with the exception of Italy.
The rest of the paper is organized as follows. Section II provides motivations for
using the fractional integration techniques and discusses the methodology to obtain
estimates for order of integration. Section III presents our main estimation results and their
implications, while Section IV reconciles over results with those in previous studies.
Section V summarizes the dynamics of inflation persistence for other G7 countries. Section
VI concludes the paper and discusses issues for further research.
In this paper, we propose using order of fractional integration to assess the level of,
and changes in, inflation persistence. Fractionally integrated processes offer a
generalization of the classical dichotomy between I(0) and I(1) processes, widely used in
macroeconomic analysis, and allow us to describe long-run persistence with more
flexibility. As a consequence, we can bypass many of the difficulties inherent in alternative
approaches. Moreover, the use of fractional integration appears well justified both on
conceptual and empirical grounds as discussed in the next subsection.
fractional difference operator (1 L) d for can be defined by means of the gamma function
() as
d (d 1) L2 d (d 1)(d 2) L3
(1 L) d = 1 dL +
+
2
3!
(k d ) Lk
=
k = 0 ( d ) ( k + 1)
The parameter d is allowed to take any real value. The arbitrary restriction of d to
integer values gives rise to the standard integrated processes. The I( d ) process is stationary
if d < 1 / 2 . The I( d ) process with d 1 / 2 is nonstationary and possesses infinite
variance, but is still mean reverting if 1 / 2 d < 1 . Importantly, the I( d ) process with
0 < d < 1 can capture the long memory characteristics, more specifically a slow rate of
decay of autocorrelations and the impulse response function which are inconsistent with
either an I(1) process or an I(0) process. While the autocorrelations of the I(0) process are
characterized by geometrical or exponential decay, the autocorrelations of an I( d ) process
with 0 < d < 1 / 2 decay more slowly.6 Specifically, autocorrelations of an I( d ) process
with 0 < d < 1 / 2 decay at a hyperbolic rate k 2 d 1 . Similarly, the impulse response
function never dies out for I(1) processes, while it decays geometrically for I(0) processes.
In contrast, the impulse response function of an I( d ) process with 0 < d < 1 decays more
10
11
change in the degree of inflation persistence. Thus, our measure is insensitive to a change
in persistence of the underlying I(0) process and can capture only a change in long-run
persistence. However, we also consider this as an advantage, because long-run persistence
is more important for our purpose, if it exists, which is indeed the case for the U.S. inflation
persistence, as we will see next.
Our study is based on monthly CPI data from Main Economic Indicators published
by OECD,7 with the sample period from 1960:4 to 2003:4. Confirming the results of
Hassler and Wolters (1995), Baillie, Chung, and Tieslau (1996) and so forth described in
the introduction, we find abundant evidence in our U.S. inflation data of fractional
integration. Figure 1 plots autocorrelations of US inflation, which show a clear pattern of
slow decay. In fact, autocorrelations for all lags up to the 84 months (7 years) are positive
and statistically significant. In addition, if we estimate order of fractional integration for
this process, the MFEWL estimator discussed below gives an estimate of 0.40 with an
We first compute the annualized inflation rate as t = 1200 * ln(CPI t / CPI t 1 ) , then we
12
asymptotic 90% confidence interval (0.32, 0.48) and a finite sample 90% confidence
interval8 (0.31, 0.53). Thus we have good initial reasons for investigating the possible
consequences of fractional integration.
(i) Aggregation: Consider the case where a time series is a cross-sectional sum of a
group of individual time series, each of which follows an AR(1) model with a common
random-walk component:
X jt = j X j ,t 1 + jWt ,
Wt = Wt 1 + t ,
where the 's and 's are assumed to be drawn from independent distributions. Then under
some fairly general conditions, in particular assuming that 's have a form of beta
distribution Beta( p, q) , p > 0 , q > 0 , Granger (1980) showed that the aggregated process
13
Since an aggregate price index is simply a weighted sum of prices of individual goods and
services, which can be modeled as above, it seems reasonable to expect fractional
integration in an aggregate price index and hence in inflation.
(ii) Structural Change: Granger and Hyung (1999) and Diebold and Inoue (2001)
showed that processes with certain kind of structural changes in mean appear
indistinguishable from long memory processes.10 Given the significant shocks that have
beset the world economy over the past three decades, as well as the likelihood of structural
change occurring over this period, a measure that allows for such change is clearly
desirable. This is reinforced by the oft discussed change in monetary policy regimes in
many of the major industrial economies following the oil price shocks of the 1970s and
early 1980s.
This result is generalized in many aspects by a number of authors. See Chambers (1998)
and Lippi and Zaffaroni (1998) for instance. See also Cioczek-Georges and Mandelbrot
(1995), Taqqu, Willinger and Sherman (1997), Parke (1999) for other examples where
aggregation causes long memory characteristics.
10
Actually this phenomenon is sometimes called spurious long memory. However, in
this paper we consider the effect of structural change as part of intrinsic inflation
persistence, which makes our study comparable to most of previous studies. Also, we will
show that the effect of structural changes is not a big problem in the next section.
14
(1 L) d X t = u t 1{t 1},
t = 0, 1, 2,
11
For instance Velasco (1999) showed that the Gaussian semiparametric estimator
analyzed by Robinson (1995) is still consistent and asymptotically normal under the
nonstationarity assumption, but only for d < 3 / 4 .
15
( k + d )
ut k .
k = 0 ( d ) ( k + 1)
t 1
Xt =
By defining the discrete Fourier transformation and the periodogram of a time series
u ( ) =
u
2n
t =1
e it , I u ( ) = u ( ) ,
I u ( j )
j =1
j =1
f u ( j )
log f u ( j ) +
, j =
2j
n
where n is sample size, and m is some integer less than n and called the bandwidth.12
When f u ( ) ~ G for ~ 0 , the objective function is simplified to be data dependent,
Qm (G, d ) =
1 m
1
log(Gj 2 d + I (1 L ) d X ( j ).
m j =1
G
Precisely the choice of the bandwidth m depends on sample size n . However, in what
16
Shimotsu and Phillips (2005) showed that under some conditions, in particular, for
d ( 1 , 2 ) with 2 1 9 / 2 ,
1
d
m (d ELW d )
N 0, ,
4
where m is chosen so that it satisfies as n
> 0 .
1 5
2 8
1
conditions for d ,2 excluding arbitrary small intervals around 0 and 1, the FELW
2
estimator has the same asymptotic distribution as the ELW estimator. This result provides a
basis for constucting valid asymptotic confidence intervals for d , which can be
supplemented with finite sample confidence intervals based on simulation. One problem in
calculating the FELW estimator concerns the choice of bandwidth m in finite samples.
17
Since there are no satisfactory analytical results for deciding on the appropriate value of m
in finite sample, we choose m based on simulation.13 We simulate X t = (1 L) d t for
t Gaussian white noise with sample size14 180 and compute the sample MSE for the
several choice of m , i.e. m = n 0.6 , n 0.65 , n 0.7 , n 0.75 , n 0.8 . The simulation results indicate that
the sample MSE is minimized when m = n 0.75 for most of the cases.15 Therefore we
choose m = n 0.75 as the bandwidth.
13
All simulations and empirical applications are performed in Matlab. Matlab codes for
the ELW and FELW estimators are available at Shimotsus web site
(http://www.econ.queensu.ca/pub/faculty/shimotsu/).
14
15
We estimator generate 3000 fractional Gaussian white noise series and compute the
sample mean squared errors (MSE) of estimates with c = 0.6 to define (d ) for the
FELW estimator. To save space, none of the simulation results are reported here, but are
available from the authors upon request.
16
18
the estimate of d 1 . Using simulation techniques, we confirmed that this strategy could
mitigate this problem without losing the good finite sample properties of the FELW
estimator. We refer to this estimator as the modified FELW (MFELW) estimator. The
simulation results indicate that also for the MFELW estimator the optimal choice of
bandwidth is also m = n 0.75 . Note further that this modification does not affect the
asymptotic distribution of the FELW estimator under some further conditions on d .17
Therefore we can construct the asymptotic confidence interval based on the asymptotic
results of the FELW estimator discussed above.
To investigate the stability of our estimates, we also compute the estimates by the
GPH estimator and the ELW estimator with estimating unknown mean by the sample
average. The GPH estimator is proposed by Geweke and Proter-Hudack (1983). The GPH
estimator is also known as the log periodogram regression estimator, since it estimates the
approximate rate of divergence of the spectrum at frequency around zero by regression of
log periodogram. More precisely, d is estimated from the following log periodogram
regression,
17
By personal discussion with Shimotsu, we confirmed that the asymptotic result is valid
at least if d is not too close to 0, which is the most of the case of our estimation results.
19
j
log I u ( j ) = d log 4 sin 2
2j
+ j , j =
, j = 1, , m
n
where log I u ( j ) is the periodogram defined above and m is the bandwidth. The GPH
estimator is defined as the OLS estimate of d in the log periodogram regression. Knsch
(1986), Robinson (1995), and Hurvich, Deo, and Brodsky (1998) rigorously analyzed its
asymptotic properties. Specifically, Hurvich et al. (1998) showed that under some
conditions,
2
d
.
m (dGPH d )
N 0,
24
Both the GPH and the ELW estimators also have the choice of bandwidth. Based on the
simulation results we choose m = n 0.8 for the GPH estimator and m = n 0.75 for the ELW
estimator. Those simulation results also indicate that the MFELW estimator has the best
finite sample properties among these three estimators.
In this paper, we test the null hypothesis that there has been no significant decline
in the persistence of inflation in the United States over the past four decades. This
hypothesis is tested against the alternative that there has indeed been a marked and
sustained change in inflation persistence. In other words, we test the null hypothesis of
20
constant d against the alternative of time-varying d . The discussion below makes clear
that while the overall conclusion is unambiguous and unaffected by the sort of statistical
considerations that beset other studies in the area, there are a number of important details
that need particular attention.
For each case, we compute the three estimates discussed above: the MFELW
estimator, the ELW estimator with estimating unknown mean by sample average, and the
GPH estimator. These three estimates allow us to test the robustness of the results over a
range of priors regarding the parameters of the underlying process.
We consider first the estimates for d provided in Table 1. The table reports
estimates and their asymptotic standard errors using three estimators for two subsample
periods. The first estimate is for the subsample from May 1960 to April 1982; for this
period, the MFELW estimator takes a value of 0.51. The second estimate is for the
non-overlapping subsample from May 1982 to April 2003; for this period, d has a value
of 0.27. As the p-values for the null hypothesis H 0 : d1 = d 2 against the alternative
hypothesis H 1 : d1 d 2 indicate, this marked decline in the inflation persistence
21
parameter is highly significant.18 Results using alternative estimators (GPH and ELW)
provide similar and equally unambiguous conclusions. The conclusion is that there has
been a pronounced and marked decline in inflation persistence in the United States from
early 1980s onwards compared to the two decades before.
We obtain additional insight and further support for these conclusions by estimating
the d parameter using a 15-year rolling window.19 The basic procedure is to estimate the
persistence parameter d using the first 15 years of data (specifically, from May 1960 to
April 1975). The data are then updated by 1 year increments, and the persistence parameter
is re-estimated for the updated window (that is, for the period May 1961 to April 1976).
18
Var(d1 d 2 ) , viz.
Var (d1 d 2 ) = Var(d1 ) + Var (d 2 ) 2Cov(d1 , d 2 ) Var (d1 ) + Var(d 2 ) ,
since Cov(d1 , d 2 ) is expected to be positive. We also compute finite sample p-values
based on the simulated finite sample distribution of d1 d 2 using 3000 fractional
Gaussian white noise series with the estimated value d = 0.40 .
19
We also examined a number of alternative rolling windows, viz. 20, 18, 15, 12 and 10
year windows and obtained qualitatively the same results. Those results are available from
the authors on request.
22
This procedure is repeated until the end of the sample period; i.e., the last value of d is
based on the period May 1988 to April 2003.
It is apparent that the fractionally integrated process implemented in this way can
yield a significant amount of information about the underlying dynamics of the inflation
process. It can also help highlight the periods over which there would likely have been
pronounced changes in the persistence parameters. To get a flavor of the results and
conduct formal tests, Table 3 reports results from estimates over the 15-year window for
the three nearly non-overlapping subsamples.20 For the MFELW estimator, with the period
ending 1975, d parameter has a value of 0.44. This increases slightly over the following
period, so that by 1989, the parameter has a value of 0.53. However, the p-value for the null
hypothesis H 0 : d1 = d 2 against the alternative hypothesis H 1 : d1 d 2 shown in Table 3
suggests this change is not statistically significant. This result illustrates that inflation
persistence was high and approximately unchanged over the three-decade period before
1989. As column 3 of the Table indicates, over the following period ending in 2003, there
is a marked decline in inflation persistence with d = 0.25 . As the p-value for the null
20
Asymptotic standard errors of the MMFELW, GPD, and ELW estimates for the 15-year
window are easily calculated for the results discussed in the previous section. They are
0.071, 0.080, and 0.071, respectively.
23
Tables 1 to 3 provide further support for the results by giving point estimates for
discrete periods. The methodology readily permits a generalization of the above by
allowing computation of rolling estimates over contiguous periods. We present these
estimates in Figure 2 with each graph showing three estimates of d and the finite sample
90% confidence interval of the MFELW estimates against the end year of an estimated
sample, respectively.21 Figure 2 provides a striking illustration of the sharp decline in d
at the beginning of the last decade. It indicates that inflation persistence increased gradually
during the first decade ending in 1985 and remained almost unchanged in the following
decade ending in 1995, then declined rapidly and remained low until the present day. Note
that Figure 2 is drawn against the end year of estimated samples. In other words, we detect
the decline of inflation persistence once we start using samples starting early 1980s. When
21
Although for the estimates of d we provide the estimates of three estimators, in what
follows we will focus on the estimates of the MFELW estimator. However the results of the
other two estimates lead qualitatively to the same conclusions.
24
we re-estimate the persistence parameter using other time windows, similar sharp declines
are observed, in which all of them start with samples from the early 1980s. These results
provide further evidence for a decline in inflation persistence around early 1980s.
One concern regarding our empirical results is the robustness against the choice of
the bandwidth m . We choose m = n 0.75 for the MFELW estimator based on simulation.
The simulation, however, assumed that the true model is a Gaussian fractional white noise
without short-run dynamics. Therefore in the presence of additional autoregressive serial
correlation our estimates might have tremendous bias (as reported Agiakloglou, Newbod
and Wohar (1993)) for the GPH estimator.22 As a robustness check Figure 3 provides the
15-year rolling window estimates of the MFELW estimator using several bandwidth
choices. Indeed there are some differences depending on the bandwidth, but the basic
results are same. That is, we find the decline of inflation persistence around the early
1980s. More importantly, more striking results can be found, if we use smaller bandwidths,
which are suitable for processes with short-run dynamics.
22
25
23
These estimates coincide with the Hsus result (1973:1 and 1981:9) under the
assumption of two breaks. Also, these are very close to the timings of the two breaks used
by Bos, Franses, and Ooms (1999) exogenously (1973:7 and 1982:7).
26
studies findings on the timing of a possible structural change towards stability in the U.S.
economy. For instance, Clarida, Gali and Gertler (2000) estimated a forward-looking
monetary policy function. They showed that there were indeed substantial differences in the
parameters of Taylor rules between pre- and post- 1979. Goodfriend (2005) argued that the
Fed adopted inflation targeting policy gradually and implicitly since the early 1980s. Also,
Kim and Nelson (1999) and McConnell and Perez-Quiros (2000) found that there was a
reduction in the volatility of output in 1984. Our empirical results suggest that there have
been corresponding changes in inflation persistence toward stabilizing the U.S. economy.
27
studies can be broadly divided into two methodological types, depending on persistence
measures. Studies in the first category use order of integration as the measure of inflation
persistence. More precisely, they use unit root tests and measure inflation persistence by
classifying the inflation process as either an I(0) or I(1) process. One important and obvious
drawback of this measure is the dichotomous nature of the statistic and the researchers
inability to further distinguish between I(0) or I(1) process. Moreover, classification into an
I(0) or I(1) process can be far too restrictive. In other words, it is hard to capture persistence
that is not consistent with either an I(1) or an I(0) process. Indeed, as we discussed in the
previous section, Figures 3 indicates that most of the estimates for order of integration are
significantly different from either zero or one. This may account for the fact that previous
studies provide divergent results depending on the particular sample periods and methods.
In particular, Hassler and Wolters (1994) argued that, under the presence of fractional
integration, ADF tests with large AR model have very low power to reject the I(1) null
hypothesis. As a consequence, under the presence of fractional integration the ADF test
based on a small AR model and a large AR model can provide inconsistent conclusions.
To confirm this more clearly, we conducted Augmented Dickey Fuller (ADF) unit
root tests to the US inflation rate. We compute ADF statistics for the null hypothesis
28
H 0 : inflation process is I(1), using three model specifications: AR(3), AR(6), and AR(12)
models with a constant term to capture non-zero mean. The results using the whole sample
and the range of subsamples used in the previous section are shown in Table 4 to 6. These
tables illustrate the extreme dependence on the sample periods and testing model
specifications. One interesting result in Table 4 is that if we use the AR(12) model, the US
inflation rate is classified as an I(1) process, identical to the suggestions of MacDonald and
Murphy (1989) and Evans and Wachtel (1993). On the other hand, if we use the AR(3) and
AR(6) models, the US inflation rate is described as I(0) process, in accordance to what
Rose (1988) indicated. Another disquieting result is that if we use the AR(6) and AR(12)
models and two subsamples, there is evidence of a decline in the US inflation persistence as
can be seen in Table 5; however, if we use the AR(3) model, the evidence disappears and
US inflation rate is seen to be I(0) for both subsamples. In addition, Table 6 provides
various results regarding the dynamics of inflation persistence. These inconsistent results of
ADF tests can provide one reason for the divergent results of the previous studies.
The second category of previous studies uses AR model-based measures. Since the
AR model can be regarded as a linear prediction, the AR model-based measures can be
interpreted as measures of persistence of linear predictions. Therefore, by using these
measures we can always measure persistence in a meaningful way. A second attractive
29
degree of fractional integration, the LARR test of Stock (2001) and Pivetta and Reis (2006)
are unlikely to detect the change.
The above observations could possibly explain the conflicting conclusions from
previous studies. To illustrate this possibility, we also estimate the LARR and the SARC of
30
an AR(12) model. Figure 5 shows estimates of the LARR and the SARC of AR(12) model
using a 15-year window. As can be seen, both the order of fractional integration and the
SARC declined dramatically at the beginning of the last decade, while the LARR remained
high and unchanged. Stock (2001) and Pivetta and Reis (2006) found similar results using
the LARR and concluded that inflation persistence in the U.S. was high and approximately
unchanged over the past 40 years. Therefore, if one uses only LARR as a measure of
inflation persistence, the conclusion would not be a decline in inflation persistence.
However, if one chooses the SARC or order of fractional integration as the measure, the
conclusion of declining persistence is borne out. Those results are also consistent with
findings of Taylor (2000), Cogley and Sargent (2001, 2005).24
In the previous sections, we found that there has indeed been a significant decline
in inflation persistence in the United States over the past two decades. It would be
24
Actually they use the spectrum at frequency zero as the measure of inflation persistence.
However, as discussed before it is monotonically related with the SARC. Therefore their
results are qualitatively the same as those for the SARC.
31
instructive to examine the extent to which there has been a commensurate decline in
inflation persistence in other G7 countries.
Each diagram in Figure 6 plots the MFELW estimates of the 15 year window for
the United States (broken line) and other G7 countries (solid line). As can be seen, there are
remarkable similarities between the dynamics of inflation persistence in the U.S. and other
G7 countries except for Italy. In particular, the similarities between the dynamics of
inflation persistence in the U.S. and France are striking. They are practically same overall
four decades. Also exhibited are parallel behaviors between the dynamics of inflation
persistence in the United Kingdom and Germany. Their dynamics of inflation persistence
were similar to those in the U.S. for the first three decades, but their declines over the last
decade were somewhat milder than that observed in the U.S. The dynamics of inflation
persistence in Canada moved differently for the decade ending in 1995; however, otherwise
it shifted similarly to that in the U.S. As a consequence of these observations, the degree of
inflation persistence in those five countries became closer toward the end of sample period.
Even though there is a difference in level between inflation persistence in the U.S.
and Japan, their dynamics are also considerably parallel except for the last five years.
Inflation persistence over the past five years in the U.S. is fairly stable, while inflation
32
persistence in Japan seems to be increasing, which could reflect the concern about deflation
experienced in Japan over the past five years.
There has been a significant interest in recent years in assessing the extent of a
possible structural shift in the dynamics of the inflation process in the United States. A
number of detailed and rigorous empirical studies regarding changes in inflation persistence
have, however, reached conflicting results. Several studies suggest little or no change over
the past four decades, while others suggest a pronounced decline over the same period.
Given the policy and market importance of this issue, this divergence in findings is both
remarkable and unsettling.
33
This paper presented a variety of evidence for the existence of long-run persistence
in the U.S. inflation. We argued that a fundamental reason for the divergence in previous
results is inappropriateness of the econometric tools given that inflation does exhibit
long-run persistence. Utilizing a more appropriate but quite general technique based on
fractional integration yields the clear conclusion that there has indeed been a significant
decline in inflation persistence in the United States over the past two decades. Moreover,
this decline was preceded by a mild increase in the persistence parameter during the late
1960s and 1970s. These conclusions are not overly sensitive to the sample period nor to the
precise estimation procedure.
The paper also investigated the extent to which there has been a commensurate
decline in inflation persistence in other G7 countries. We found similar declines for France
and Japan, and similar but milder declines for the United Kingdom and Germany. Inflation
persistence in Canada experienced a decline only for the last decade. We also found
inflation persistence in Italy had been high and approximately unchanged over the past four
decades.
These conclusions raise the obvious question regarding factors behind the decline
in inflation persistence. A number of other studies have already examined the extent to
34
which a decline in the average rate of inflation and its volatility may reflect increasing
globalization and competition (both domestic and international), the role of the
informational technology revolution, increasing productivity growth, as well as improved
monetary policy design.25 These factors are probably also important in explaining the
decline in inflation persistence. In general if the conclusions of this study are regarded as
robust, and we believe they are, an analysis of the determinants of the decline in persistence
in G7 countries would be a useful agenda for further research. In addition, it would be
instructive to examine the extent to which there has been a commensurate decline in
inflation persistence elsewhere in the other major industrial, as well as emerging market
economies, and assess the importance of the common factors that might have led to such an
outcome.
See, for instance, Clarida, Gali and Gertler (2000), Goodfriend (2005), and Rogoff
(2004).
35
formally in the fractional integration specification is an important future work. Hidalgo and
Robinson (1996) and Bos, Franses and Ooms (1999) provide good starting points for this
problem.
Another avenue relates to the measurement of the short-run as well as the long-run
persistence so that we can describe the persistence structure itself more precisely. One
possibility is the ARFIMA modeling. As discussed in Section 2, we can capture the
long-run persistence through order of fractional integration and the short-run persistence
through ARMA model. A formal modeling of time-varying variance could also be useful.
There is universal agreement on a reduction in variance and oftentimes it is misunderstood
as a reduction in persistence. By explicitly modeling time-varying variance, this confusion
can be clarified. ARFIMA-GARCH model proposed by Baillie, Chung and Tieslau (1996)
is one attractive model for those topics.
The final and perhaps the most important topic is to model the dynamics of inflation
persistence more explicitly. Our results strongly suggest that the order of fractional
integration is changing over time. Therefore constructing the time-varying order fractional
integration model could be a fruitful endeavor. Granger and Ding (1996) suggest using state
space modeling and regime switching modeling for this purpose, and the Bayesian MCMC
36
method could also be used in this context. Since the MCMC method provides a convenient
framework to estimating complicated models, it might be particularly useful to estimate the
time-varying order fractional integration model.
37
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42
1960.5-1982.4 1982.5-2003.4
MFELW
0.509
0.268
(asy. s.e.)
(0.062)
(0.063)
GPH
0.587
0.267
(asy. s.e.)
(0.069)
(0.070)
ELW
0.566
0.268
(asy. s.e.)
(0.062)
(0.063)
asy. p-values
f.s. p-values
0.000
0.057
0.000
0.022
0.000
0.015
MFELW
0.439
0.532
0.252
GPH
0.517
0.539
0.297
ELW
0.515
0.565
0.252
d1=d2
d2=d3
asy. p-values
f.s. p-values
asy. p-values
f.s. p-values
MFELW
0.514
0.437
0.050
0.029
GPH
0.848
0.850
0.033
0.077
ELW
0.725
0.663
0.028
0.011
43
Tables 4: Results of ADF unit root tests for US inflation (whole sample)
Sample period
1960.5-2003.4
Model
AR(3)
AR(6)
AR(12)
ADF statistics
-4.650**
-3.136*
-2.573
P-values
0.000
0.025
0.099
Tables 5: Results of ADF unit root tests for US inflation (two subamples)
Sample period
1960.5-1982.4
1982.5-2003.4
Model
AR(3)
AR(6)
AR(12)
AR(3)
AR(6)
AR(12)
ADF statistics
-2.896*
-2.059
-1.955
-6.573**
-4.682**
-3.182*
P-values
0.047
0.262
0.307
0.000
0.000
0.022
Tables 6: Results of ADF unit root tests for US inflation (three subsamples)
Sample period
1960.5-1975.4
1974.4-1989.5
1988.5-2003.4
Model
AR(3)
AR(6)
AR(12)
AR(3)
AR(6)
AR(12)
AR(3)
AR(6)
AR(12)
ADF statistics
-2.503
-1.393
-1.654
-3.238*
-2.283
-1.838
-4.551**
-3.270**
-2.539
P-values
0.117
0.585
0.453
0.019
0.179
0.361
0.000
0.018
0.108
44
0.8
0.7
Autocorrelation
0.6
0.5
0.4
0.3
0.2
0.1
0
-0.1
0
20
40
60
Lag
45
80
100
120
0.9
MFELW
0.8
GPH
0.7
ELW
0.6
f. s. lb of
MFELW
f. s. ub of
MFELW
0.5
0.4
0.3
0.2
0.1
0
1975 1978 1981 1984 1987 1990 1993 1996 1999 2002
46
0.7
0.6
m
=n0.6
m=
n
0.6
0.65
m=n0.65
=n
m
0.5
0.7
m
=n0.7
m=
n
0.75
m
=n0.75
m
=n
0.4
0.8
m
=n0.8
m
=n
0.3
0.2
0.1
0
1975 1978 1981 1984 1987 1990 1993 1996 1999 2002
47
0.65
MFELW
MFELW2
0.6
0.55
0.5
0.45
0.4
0.35
0.3
0.25
1975 1978 1981 1984 1987 1990 1993 1996 1999 2002
48
Figure 5: Dynamics of persistence in US inflation rate based on the LARR and SARC
MFELW
LARR
SARC
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
1975 1978 1981 1984 1987 1990 1993 1996 1999 2002
49
France
Germany
0.7
0.7
0.7
0.6
0.6
0.6
0.5
0.5
0.5
0.4
0.4
0.4
0.3
0.3
0.3
0.2
0.2
0.2
0.1
0.1
0.1
0
1975 1979 1983 1987 1991 1995 1999 2003
0
1975 1979 1983 1987 1991 1995 1999 2003
0
1975 1979 1983 1987 1991 1995 1999 2003
United Kingdom
Japan
Italy
0.7
0.7
0.7
0.6
0.6
0.6
0.5
0.4
0.3
0.2
0.1
0
1975 1979 1983 1987 1991 1995 1999 2003
0.5
0.5
0.4
0.4
0.3
0.3
0.2
0.1
0.2
0.1
-0.1
1975 1979 1983 1987 1991 1995 1999 2003
50
0
1975 1979 1983 1987 1991 1995 1999 2003