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This paper develops an empirically constant, data-coherent, error correction model for inflation in Australia. The level of consumer prices is a mark-up over domestic and import costs, with adjustments for dynamics and relative aggregate demand. We address issues of cointegration, general to specific modelling, dynamic specification, model evaluation and testing' parameter constancy, and exogeneity. We also test this model against existing models of Australian prices: this model encompasses (but is not encompassed by) the existing models.
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Brouwer et al. (1995) studied this question.
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