Measuring macroeconomic convergence and divergence within EMU using long memory.

Abstract

This paper tests for convergence of EMU inflation rates and industrial production by testing for the existence of fractional cointegration relations. The notion of fractional cointegration allows for long-term equilibria with a higher degree of persistence than allowed for in the standard cointegration framework. Over the full sample from 1999:Q1-2021:Q4, we find evidence of fractional cointegration in both inflation and industrial production among many country pairs. Our results suggest some evidence for "convergence clusters" among either core or periphery countries in the case of inflation. Similarly, we find stronger evidence of cointegration pairs among core countries for industrial production compared to periphery or mixed core-periphery groups. Testing for a break in the persistence structure, the results show evidence of a break in the persistence of both inflation and industrial production in a number of countries. Inflation persistence is substantially higher after the break, suggesting a higher potential for diverging processes during economic crises. On the contrary, for the case of industrial production, persistence is lower during the post-crisis period.