The relationship between prices and output in the UK and the US

Abstract

AbstractThis paper aims to provide new evidence on the relationship between prices and output in both the US and the UK (which is important to discriminate between different macroeconomic theories) by focusing on the long run. For this purpose, it applies fractional integration and long-range dependence techniques that are more general than the standard modelling approach based on the stationary I (0) versus nonstationary I (1) dichotomy which has been used in previous studies. All series appear to be highly trended and to exhibit high degrees of integration and persistence, especially in the case of CPI. Since the two variables have different degrees of integration in each of the two countries, fractional cointegration tests cannot be carried out. We assume instead weak exogeneity of each of them in turn and test for causality by regressing the other variable against lagged values of the weakly exogenous one. We find that the only significant relationship implies the existence of a lagged effect of prices on output in the case of the US, which suggests a dominant role for demand shocks.