A two-states Markov-switching model of inflation in France and the USA: credible target VS inflation spiral

This paper seeks to apply the general framework of Markov-switching models to inflation in France and in the USA. We propose a model where inflation can, alternatively, follow two regimes: the first one, where inflation is stationary, is interpreted as a situation where there exists a credible inflation target, even if it is not explicit; the second one where inflation is integrated. Moreover, observing that the two oil shocks were followed by accelerating inflation periods, we allow dependency of the transition probabilities over the variations of oil price. The model is estimated resorting to an EM algorithm. The results of these modelling are threefold: the influence of oil price variations over the transition probabilities are not significant; American inflation has generally a credible inflation target, apart from some specific episodes; inflation in France experienced a dramatic change with the policy of competitive disinflation, then acquiring a credible inflation target. Inflation; Markov-switching regimes; transition probability; oil shock