Economic Freedom and Price Stability in the European Union: A Panel Causality Investigation

Abstract

This study examines the causal relationship between inflation and economic freedom in 27 European Union (EU) countries, with a particular focus on differences between Euro Area and non-Euro Area members. The analysis is motivated by the hypothesis that economic freedom affects inflation by enhancing monetary credibility, strengthening policy discipline, and anchoring inflation expectations, while inflation may, in turn, undermine economic freedom by distorting market signals and triggering regulatory and policy interventions. To properly account for cross-sectional dependence driven by monetary integration and common macroeconomic shocks, the study employs a Panel Vector Autoregression model with unobserved common factors, following Nazlioglu and Karul (2024). Panel-level inferences are obtained using a meta-analytic approach based on individual probability values of Wald statistics, allowing for heterogeneity in causal dynamics among EU member states. The results indicate strong bidirectional causality between inflation and economic freedom at the panel level. However, the direction of causality varies across countries. Bidirectional effects are more pronounced among Euro Area members, reflecting the disciplining role of shared monetary institutions and policy credibility. In contrast, non-Euro Area countries display weaker and more complex causal patterns highlighting the role of national monetary autonomy and exchange rate dynamics.

Keywords

• Economic freedom
• Inflation
• Panel causality
• European Union

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