Structural breaks and regional inflation convergence for five new Euro members

Abstract

Following Euro adoption, it is expected that a country’s inflation rates and other macroeconomic variables will continue to converge to those of other members of the bloc. But fixed exchange rates can cause macroeconomic adjustment to take place through goods prices, and varying geographic and historic ties might lead to different degrees of inflation convergence among economic regions. This study examines monthly inflation series for five Central and Eastern European Euro members, testing for structural breaks before analyzing correlations and stationary inflation differentials versus four regional country groups. Overall, certain regional groupings have stronger connections than others post-Euro, such as Estonia with its Nordic neighbors and, more recently, with the largest EU economies. We find that no CEE inflation rate has a breakpoint that corresponds specifically to Euro adoption. Instead, all countries have multiple breaks, and four inflation series have a final structural break occurring in 2013, after which general convergence versus all four regions increased.