Did the Underlying Behaviour of Inflation Change in the 1980s? A Study of 17 Countries

During the 1980s, the reduction of inflation was a major policy objective for many countries. However, a key question is whether these deflationary policies merely reduced the level of inflation or actually changed the underlying process determining inflation. In this paper we examine the persistence of inflation in order to judge whether the underlying behaviour of inflation changed in the 1980s. This is an important question as a reduction in the persistence of inflation will reduce the unemployment costs of deflationary policies.

Membership of the ERM implies that countries should adopt policies which, via several transmission mechanisms, will reduce the persistence of inflation. The primary objective of this study is to discover whether the ERM member countries have experienced a regime change to a lower degree of persistence for inflation in the 1980s compared to the 1970s. In addition, the process determining inflation in some non-ERM countries - some following restrictive anti-inflation policies and some not - is evaluated and compared with members of the ERM in order to see if there is any discernible difference.

The results provide mixed evidence of the achievements of the ERM. Some results give the impression that deflationary policies associated with ERM membership may have reduced the mean level of inflation, but did not reduce the persistence parameter over the last decade. Conversely, if we do not allow for a change in the mean of inflation we find that the persistence parameter does decline for a majority of ERM members. Furthermore, the results show stronger evidence of a fall in inflation persistence for the non-ERM countries who adopted a strong anti-inflationary stance.

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