LONG MEMORY PROCESSES AND CHRONIC INFLATION - DETECTING HOMOGENEOUS COMPONENTS IN A LINEAR RATIONAL-EXPECTATIONS MODEL

This paper is an empirical study of the links between monetary variabl es and inflation based on Cagan's equation and its rational expectatio ns solution, when the forcing variable is a fractionally integrated pr ocess. As demonstrated by Hamilton and Whiteman, the existence of bubb les and other extraneous influences can be detected only by verifying the difference in the order of integration between the monetary base a nd the price level series. This paper shows that a test based on fract ional differencing overcomes Evans' critique and that chronic inflatio n is essentially a monetary phenomenon caused by fiscal imbalance.