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Dear forum participants.

For my bachelor thesis i'm researching inflation persistence. I am currently struggling with finding a suitable model for the corresponding regression specification: inflation=c+inflation(-1).
Since inflation is a non stationary process, OLS is unsuitable, unless i transform the series. Logarithmic transformation is not possible, since in some cases there is deflation (negative inflation).
Taking the first difference is not suitable either, since d(inflation)=c+d(inflation(-1)) no longer tests inflation persistence.

Any advice on how to resolve this issue would be greatly appreciated,

Thanks in advance,

Thomas.

20 views and no response yet, someone has to have an idea?

How do you define persistence?

Persistence in this case means that inflation is dependent on its past value.
so : inflation = c+b1inflation(-1)+et. If b1 turns out to have a high value, i say that inflation is very persistent.
Hope you can give me some more advice on the basis of this information :)

If you do it in first differences, then inflation is still dependent on past values--just in a more complicated way.

In fact, if inflation is nonstationary then shocks persist forever.

You might want to look up "impulse response function"

Thank your for this insightful comment. My supervisor told me that d(inflation)=c+d(inflation-1) would not measure persistence, but i think, like you, that he's probably wrong on this part. If inflation at time t increased with 2 percent, and at time t+1 with 1.8 percent, then inflation finds it hard to get back to a 0 (or negative increase). Yes, i think this reasoning is logical, lets hope my supervisor agrees. Thanks