Empirical Economics

, Volume 31, Issue 3, pp 569–586 | Cite as

Inflation adjustment in the open economy: an I(2) analysis of UK prices

Original Paper

Abstract

This paper estimates a cointegrated vector autoregressive (VAR) model for UK data on consumer prices, unit labour costs, import prices and real consumption growth. The estimated VAR indicates that the nominal variables are characterised by I(2) trends, and that a linear combination of these processes cointegrate to I(1). This supports an analysis in which I(1) and I(2) restrictions are imposed. A key finding is that an increase in real import prices reduces productivity adjusted real wages, such that the change in domestic inflation is moderated. This may explain why the depreciation of sterling in 1992 left inflation unchanged.

Keywords

Cointegration I(2) Inflation Import prices 

JEL Classification

C32 C51 C53 E31 F0 

References

  1. Banerjee A, Cockerell L, Russell B (2001) An I(2) analysis of inflation and the markup. J Appl Econ 16:221–240CrossRefGoogle Scholar
  2. Banerjee A, Russell B (2001) The relationship between the markup and inflation in the G7 economies and Australia. Rev Econ Stat 82(2):377–387Google Scholar
  3. Bank of England (1999): Economic models at the Bank of England, Bank of England, LondonGoogle Scholar
  4. Batini N, Jackson B, Nickell SJ (2005) An open economy New Keynesian Phillips curve for the UK, J Monet Econ, 52:1061–1071Google Scholar
  5. de Brouwer G, Ericsson N (1998) Modelling inflation in Australia. J Bus Econ Stat 16:433–449CrossRefGoogle Scholar
  6. Diamandis PF, Georgoutsos DA, Kouretas GP (2000) The monetary model in the presence of I(2) components: long-run relationships, short-run dynamics and forecasting of the Greek drachma. J Int Money Financ 19:917–941CrossRefGoogle Scholar
  7. Doornik JA (1998) Approximations to the asymptotic distribution of cointegration tests. J Econ Surv 12(5):573–593CrossRefGoogle Scholar
  8. Doornik JA (2001): Object-oriented matrix programming using Ox, Timberlake Consultants, London, 4th editionGoogle Scholar
  9. Doornik JA, Hendry DF (2001) Empirical Econometric Modelling Using PcGive, Volumes I, II and III, Timberlake Consultants, LondonGoogle Scholar
  10. Ericsson NR, Hendry DF, Tran H-A (1994) Cointegration, seasonality, encompassing and the demand for money in the United Kingdom. In: Hargreaves CP (ed) Nonstationary time series analysis and cointegration, Oxford University Press, Oxford, pp. 179–224Google Scholar
  11. Gredenhoff M, Jacobson T (2001) Bootstrap testing linear restrictions on cointegrating vectors. J Bus Econ Stat 19(1):63–72MathSciNetCrossRefGoogle Scholar
  12. Haldrup N (1998) A review of the econometric analysis of I(2) variables. J Econ Surv 12:595–650CrossRefGoogle Scholar
  13. Hendry DF, Krolzig H-M (2001) Automatic econometric model selection using PcGets 1.0, Timberlake Consultants, LondonGoogle Scholar
  14. Jacobson T, Vredin A, Warne A (1998) Are real wages and unemployment related? Economica 65(267):69–96CrossRefGoogle Scholar
  15. Johansen S (1992) A representation of vector autoregressive processes integrated of order 2. Econom Theory 8:188–202MathSciNetGoogle Scholar
  16. Johansen S (1995) A statistical analysis of cointegration for I(2) variables. Econom Theory 11:25–59MathSciNetADSCrossRefGoogle Scholar
  17. Johansen S (1996) Likelihood-based inference in cointegrated vector autoregressive models, 2nd edition. Oxford University Press, OxfordMATHGoogle Scholar
  18. Johansen S (1997) Likelihood analysis of the I(2) model. Scand J Statist 24:433–462MATHMathSciNetCrossRefGoogle Scholar
  19. Johansen S (2004) Statistical analysis of hypotheses on the cointegrating relations in the I(2) model. J Econom, (in press)Google Scholar
  20. Juselius K (1998) A structured VAR under changing monetary policy. J Bus Econ Stat 16(4):400–412CrossRefGoogle Scholar
  21. Kongsted HC (2003) An I(2) cointegration analysis of small-country import price determination. Econom J 6:53–71MATHMathSciNetCrossRefGoogle Scholar
  22. Kongsted HC, Nielsen HB (2004) Analyzing I(2) systems by transformed vector autoregressions. Oxf Bull Econ Stat, 66(3):379–397Google Scholar
  23. Layard PRG, Nickell SJ, Jackman R (1991) Unemployment, macroeconomic performance and the labour market, Oxford University Press, OxfordGoogle Scholar
  24. Li H, Maddala GS (1997) Bootstrapping cointegrating regressions. J Econom 80:297–318MATHMathSciNetCrossRefGoogle Scholar
  25. Lütkepohl H (1991) Introduction to multiple time series analysis, Springer, Berlin Heidelberg New YorkMATHGoogle Scholar
  26. Nielsen HB (2002) An I(2) cointegration analysis of price and quantity formation in Danish manufactured exports. Oxf Bull Econ Stat 64(5):449–472CrossRefADSGoogle Scholar
  27. Nielsen HB (2004a) Cointegration analysis in the presence of outliers. Econom J 7(1):249–271MATHMathSciNetCrossRefGoogle Scholar
  28. Nielsen HB (2004b) A ‘Maximum-Eigenvalue’ test for the multi-cointegration ranks in I(2) VAR models, Working Paper, Institute of Economics, University of CopenhagenGoogle Scholar
  29. Nielsen B, Rahbek A (2000) Similarity issues in cointegration analysis. Oxf Bull Econ Stat 62(1):5–22CrossRefGoogle Scholar
  30. Nielsen HB, Rahbek A (2003) The Likelihood Ratio Test for (Multi-) Cointegration Ranks in the I(2) VAR Model, Discussion Paper 03–42, Institute of Economics, University of CopenhagenGoogle Scholar
  31. Rahbek A, Kongsted HC, Jørgensen C (1999) Trend-stationarity in the I(2) cointegration model. J Econom 90:265–289MATHCrossRefGoogle Scholar

Copyright information

© Springer-Verlag 2006

Authors and Affiliations

  1. 1.Economics DepartmentUniversity of CopenhagenCopenhagenDenmark
  2. 2.Nuffield CollegeUniversity of OxfordOxfordUK

Personalised recommendations