Nonlinearity and stationarity of inflation rates: Evidence from the euro-zone countries

Few studies have empirically examined the possibility of nonlinearity in inflation and tested nonlinear stationarity of the inflation rates. The present study thus intends to fill the gap. The study examines the hypothesis that, for a group of countries having exercised target-zone type stabilization policies with their inflation eventually converging to similar low levels, their inflation rates would have stationary behavior. When the sample includes periods where inflation control is an alternative objective to other objectives of policymakers and central banks respond to inflation actively only when inflation deviations from the target range become large, non-linearity may exist in inflation. The hypothesis is tested for a sample over the floating exchange rate period for 12 European countries that formed the euro zone later in the sample period. The results suggest that the majority of these countries’ inflation rates can be characterized by mean reversion during the sample period. Many of them appear to be nonlinearly stationary. This finding is essential in conducting applied economic studies for these countries, when constructing models whose validity relies on whether or not inflation is stationary.