Asymmetric Behavior of Inflation Uncertainty and Friedman-Ball Hypothesis: Evidence from Pakistan

Abstract

This paper is first attempt to measure and analyze inflation uncertainty in Pakistan and it provides several contributions. Using quarterly data from 1976:01 to 2008:02, at first stage we model inflation uncertainty as time varying process through GARCH framework. At second stage asymmetric behavior of inflation uncertainty is analyzed by using GJR-GARCH and EGARCH models, for further analysis of asymmetry and leverage effects, we developed news impact curves proposed by Pagan and Schwert (1990). Finally we investigate the causality and its direction between inflation and inflation uncertainty by using bivariate Granger-Causality test to know which inflation uncertainty hypothesis (Friedman-Ball or Cukierman- Meltzer) holds true for Pakistani data. We get two important results. First, GJR-GARCH and EGARCH models are more successful in capturing inflation uncertainty and its asymmetric behavior as compared to simple GARCH model. This can also be seen from news impact curves. Second, there is strong evidence that Friedman-Ball inflation uncertainty hypothesis holds true for Pakistan.