On the persistence of UK inflation: A long‐range dependence approach

Guglielmo Maria Caporale,Tommaso Trani,Luis Alberiko Gil‐Alana

doi:10.1002/ijfe.2161

Guglielmo Maria Caporale, Tommaso Trani + Show 1 more

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https://doi.org/10.1002/ijfe.2161

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Abstract

AbstractThis paper examines the degree of persistence in UK inflation by applying long‐memory methods to historical data that span the period from 1660 to 2016. Specifically, we use both parametric and non‐parametric fractional integration techniques, that are more general than those based on the classical I(0) vs. I(1) dichotomy. Further, we carry out break tests to detect any shifts in the degree of persistence, and also run rolling‐window and recursive regressions to investigate its evolution over time. On the whole, the evidence suggests that the degree of persistence of UK inflation has been relatively stable following the Bretton Woods period, despite the adoption of different monetary regimes. The estimation of an unobserved‐components stochastic volatility model sheds further light on the issues of interest by showing that post‐Bretton Woods changes in UK inflation are attributable to a fall in the volatility of permanent shocks. The same type of analysis carried out for US inflation, for comparison purposes, leads to broadly similar conclusions.

Highlights

Inflation persistence has been extensively analysed in the literature because its properties have implications for both theoretical models and monetary policy
After World War II (WWII), the degree of inflation persistence has been high in several countries (Miles et al, 2017), but there has been controversy over whether it has remained stable throughout the post-WWII period
In addition we carry out break tests to detect any shifts in the degree of persistence and run rolling-window and recursive regressions to examine its evolution over time

Summary

Introduction

Inflation persistence has been extensively analysed in the literature because its properties have implications for both theoretical models and monetary policy. After World War II (WWII), the degree of inflation persistence has been high in several countries (Miles et al, 2017), but there has been controversy over whether it has remained stable throughout the post-WWII period. Empirical tests based on autoregressive (AR) models, namely the approach most frequently used in the literature, suggest that it may have decreased when central banks started to follow inflation-targeting policies. According to Pivetta and Reis (2007) and Stock and Watson (2007, 2010), no significant change in persistence can be detected over the post-WWII period if one accounts for uncertainty around point estimates or distinguishes between persistent and transitory changes in inflation

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