Euro Area Inflation Differentials: Unit Roots and Nonlinear Adjustment

Abstract: This article examines the time-series properties of inflation differentials in 12 economic and monetary union (EMU) countries. The evidence from standard linear unit root tests indicates that inflation differentials are highly persistent in the majority of countries. However, when one allows for the possibility that inflation differentials can be characterized by a nonlinear mean reverting process, one finds evidence of stationarity in all cases. The empirical results suggest that once nonlinearity is accounted for, inflation differentials do not consistently intensify real divergence in the euro area.