Bidirectional linkage between inflation and inflation uncertainty – the case of Eastern European countries

This paper examines inflation-inflation uncertainty nexus in both inflation targeting and non-inflation targeting economies in Asia. Using monthly data from 1979M1 to 2019M12, the AR(p)-EGARCH model is used to generate inflation uncertainty series. In addition, quantile regression is employed to examine the linkages between inflation and inflation uncertainty in nine Asian countries. The results show that inflation positively causes inflation uncertainty in all economies regardless of whether economies have implemented inflation targeting or not. The Friedman-Ball hypothesis is thus supported. In addition, inflation uncertainty positively causes inflation in most economies. Therefore, the Cukierman-Meltzer hypothesis is likely to be supported. The findings signal the possibility of the real cost of inflation for these economies.

Evidence of a nonlinear relationship between inflation and inflation uncertainty: The case of the four little dragons

Decreasing inflation uncertainty, as the major source of welfare costs, requires finding the driving factors of this variable. Counting inflation as one of the driving factors of inflation uncertainty has created some concern due to the ambiguity over the causality between inflation and inflation uncertainty. This ambiguity has inspired several studies in the literature, which mostly focuses on testing two separate hypotheses to solve this ambiguity. These hypotheses are Friedman-Ball hypothesis, which assumes higher inflation leads to higher inflation uncertainty, and Cukierman-Meltzer hypothesis, which claims the reverse. After testing for Friedman-Ball and Cukierman-Meltzer hypotheses in Iranian economy, with applying TGARCH and EGARCH models, this study reveals that EGARCH model supports the asymmetry in error terms distribution of Iranian data and accepts both hypotheses. However, results based on TGARCH approach do not support the asymmetry in error terms distribution, which implies TGARCH model is not reliable for Iranian data.

Using monthly data from 1979M1 to 2019M12, this paper employs the AR(p)-EGARCH model and quantile regression to examine the linkages between inflation and inflation uncertainty in nine Asian countries. The results show that inflation positively causes inflation uncertainty in all economies regardless of whether economies are inflation or non-inflation targeting. The Friedman-Ball hypothesis is thus supported. In addition, inflation uncertainty positively causes inflation in most economies. Therefore, the Cukierman-Meltzer hypothesis is likely to be supported. The findings signal the possibility of the real cost of inflation for these Asian economies.

The welfare costs of inflation and inflation uncertainty are well documented in the literature and empirical evidence on the link between the two is sparse in the case of Egypt. This paper investigates the causal relationship between inflation and inflation uncertainty in Egypt using monthly time series data during the period January 1974–April 2015. To endogenously control for any potential structural breaks in the inflation time series, Zivot and Andrews (2002) and Clemente–Montanes–Reyes (1998) unit root tests are used. The inflation–inflation uncertainty relation is modeled by the standard two-step approach as well as simultaneously using various versions of the GARCH-M model to control for any potential feedback effects. The analyses explicitly control for the effect of the Economic Reform and Structural Adjustment Program (ERSAP) undertaken by the Egyptian government in the early 1990s, which affected inflation rate and its associated volatility. Results show a high degree of inflation–volatility persistence in the response to inflationary shocks. Granger-causality test along with symmetric and asymmetric GARCH-M models indicate a statistically significant bi-directional positive relationship between inflation and inflation uncertainty, supporting both the Friedman–Ball and the Cukierman–Meltzer hypotheses. The findings are robust to the various estimation methods and model specifications. The findings of this paper support the view of adopting inflation-targeting policy in Egypt, after fulfilling its preconditions, to reduce the welfare cost of inflation and its related uncertainties. Monetary authorities in Egypt should enhance the credibility of monetary policy and attempt to reduce inflation uncertainty, which will help lower inflation rates.

This study examines the dynamic relationship between monthly inflation and inflation uncertainty in Japan, the US and the UK by employing linear and nonlinear Granger causality tests for the 1957: 01–2006: 10 period. Using a generalised autoregressive conditional heteroskedasticity (GARCH) model to generate a measure of inflation uncertainty, the empirical evidence from the linear and nonlinear Granger causality tests indicate a bidirectional causality between the series. The estimates from both the linear vector autoregressive (VAR) and nonparametric regression models show that higher inflation rates lead to greater inflation uncertainty for all countries as predicted by Friedman (1977). Although VAR estimates imply no significant impact, except for Japan, nonparametric estimates show that inflation uncertainty raises average inflation in all countries, as suggested by Cukierman and Meltzer (1986). Thus, inflation and inflation uncertainty have a positive predictive content for each other, supporting the Friedman and Cukierman-Meltzer hypotheses, respectively.

This paper investigates how inflation and its uncertainty impact GDP growth in eight Central and Eastern European Countries. Inflation uncertainty series are created examining several GARCH models in combination with three different distribution functions, while the nonlinear effect of inflation and its uncertainty on GDP growth is assessed in the Bayesian quantile regression framework. We find that inflation has significantly smaller negative effect on GDP growth than inflation uncertainty, which confirms the Friedman hypothesis. This means that inflation in the selected countries has an indirect impact on GDP growth via inflation uncertainty. We find that countries with smaller economy, such as Latvia and Estonia experience more adverse effect from inflation uncertainty in both upturn and downturn conditions, probably because they are vulnerable to external inflationary shocks. As for the countries with bigger economy, inflation uncertainty shocks diminish GDP growth only in conditions when output growth is very low or negative.

Aperennial topic of discussion among scholars and policymakers is how best to think about a benchmark for macroeconomics as it applies to monetary policy. Should the benchmark for policy analysis be the open economy with international interest rate linkages and flexible exchange rates (after all, major economies are in fact open with flexible exchange rates), or should it be the closed economy in which such linkages and exchange rate adjustments are assumed away? Of course, few if any policy makers would seek to guide policy by ignoring capital flows and exchange rates, but in many cases it appears as though the starting point for analysis is the closed‐economy macro model, these days a variant of the dynamic new Keynesian model. Those who start from a closed‐economy framework often have questions about how “openness” influences the analysis. How does the neutral real interest depend on “global” developments? Is the Phillips curve trade‐off between inflation and domestic output better or worse in the open versus the closed economy? Is “potential GDP” a function of global developments, or only of domestic resources available and domestic productivity? Perhaps most important, how—if at all—does openness influence the optimalmonetary policy rule? Is a Taylor rule the rightmonetary policy for an open economy? In 2002 Jordi Gali, Mark Gertler, and I published a paper in the Journal of Monetary Economics that developed a benchmark (at least in ourway of thinking) dynamic two‐country optimizing macro model of optimal monetary policies in the open economy. Our focus in that paper was deriving optimal policy rules in the two‐country model and assessing the gains from international monetary policy cooperation. In that paper, we emphasized the following implications of the model:

Using Taiwan data, the study employs Hamilton's (2001) flexible regression model to investigate the relationship between inflation and inflation uncertainty. The results convincingly support Friedman's hypothesis that a rise in the inflation rate increases inflation uncertainty. This result, however, holds only in a positive inflation regime. When the inflation rate is in a negative inflation regime, one clearly notes that a drop in the inflation rate also increases inflation uncertainty. Thus Friedman's argument is complemented by advocating that a rise in the absolute inflation rate increases inflation uncertainty. Turning to Cukierman-Meltzer's hypothesis, both linear and nonlinear inflation uncertainties affect the inflation rate, where the former has positive but the latter has negative effects.

Utilizing time series data for a panel of 22 emerging countries and applying Granger causality tests, this paper extends the relationship between central bank independence (CBI) and uncertainties of inflation by including the phenomena of exchange rates and foreign capital flows. There are two specific objectives of this investigation. The first objective is to see whether uncertainty of inflation induces volatility of exchange rates, and vice versa, under differing degrees of CBI. The second objective is to explore whether the dynamics of the former relationship influence foreign capital flows in turn and, if so, whether the extent of CBI plays any role in shaping that influence. The period of study spans the years 1968 through 2013. Conditional variances for inflation and exchange rates define proxies for uncertainties of inflation and exchange rates in the empirical analysis. Additionally, annual inflows of foreign direct investment (FDI) provide measures for foreign capital flows in the analysis. Results of causality tests for high and low CBI country subgroups show interesting differences. For the high CBI countries, uncertainty of inflation and uncertainty of exchange rates do not share any causal relationship whatsoever between them. However, a weak link runs from FDI to uncertainties of inflation in the long run. This may be indicative of the disciplined monetary policy and tamed inflation in these countries. Contrastingly, for the low CBI countries, there is strong evidence of causal links running from uncertainties of inflation to uncertainties of exchange rates on the one hand and to FDI flows on the other. In addition, there is indication of a bi-directional causal link between FDI flows and exchange rates for these countries.

The aim of this study is to analyze the relationship between inflation and inflation uncertainty in Serbia. Using the GARCH model, inflation uncertainty was assessed with the EGARH model proving to be the best model. The results of the Granger causality test between inflation and inflation uncertainty showed that inflation affects the growth of inflation uncertainty in the case of Serbia and that the growth of inflation leads to the growth of uncertainty, thus confirming the Friedman-Ball hypothesis. On the other hand, the results showed that inflation uncertainty affects the growth of inflation and that the growth of inflation uncertainty affects the growth of inflation in the case of Serbia which is in accordance with Cukierman and Meltzer's hypothesis.

This study investigates the linkage between inflation and inflation uncertainty in seven transitional economies (Armenia, Azerbaijan, Georgia, Kazakhstan, the Kyrgyz Republic, the Russian Federation and the Ukraine) which experienced hyper-inflation until the mid-1990s. This linkage is investigated in the ARCH modeling framework by using both conventional Granger noncausality testing and the Holmes-Hutton approach, which has significant small- and large-sample power advantages over the former. The results support the Friedman- Ball hypothesis in Azerbaijan, the Russian Federation and the Ukraine. The Cukierman-Meltzer hypothesis is favored in the Kyrgyz Republic and in the Russian Federation using a different model. In Azerbaijan, greater inflation uncertainty preceded lower rates of inflation, indicative of the strong monetary stabilization policies pursued in this economy.

La presente investigación estudia la relación de retroalimentación entre inflación e incertidumbre inflacionaria, respecto a seis economías latinoamericanas, durante el periodo 1960-2018. La incertidumbrese calculó utilizando la volatilidad condicional estimada de modelos GJR-GARCH-M. Como principales conclusiones se obtuvieron: cumplimiento de la hipótesis de Friedman-Ball para la mayoríade las economías; comprobación de la hipótesis de Cukierman-Meltzer para Bolivia, México y Paraguay; identificación de un mayor impacto de los choques positivos en la incertidumbre inflacionaria y, finalmente, gracias a la adopción del régimen de metas de inflación (mi), evidencia empírica sobre que la volatilidaddisminuyó en las economías que implementaron dicho esquema

Inflation uncertainty causes macroeconomic ills and instability in the economy. This paper investigates if rising levels of inflation uncertainty serve as a source of higher inflation outcomes or vice versa, to determine if inflation uncertainty is potentially a self‐fulfilling prophecy. In addition, this paper examines the impact of inflation targeting, implemented in South Africa in February 2000, on the level of inflation and inflation uncertainty. Using a generalised autoregressive conditional heteroskedasticity (GARCH) and GARCH‐in‐mean model and monthly data spanning the period 1970:01 to 2022:05, the empirical outcomes from this study suggest the existence of a bi‐directional relationship between inflation and inflation uncertainty, with strong evidence in favour of the Friedman–Ball hypothesis and weaker evidence in support of the Cukierman–Meltzer hypothesis. This study also finds that inflation targeting has contributed significantly to reducing the level of inflation and inflation uncertainty since its adoption as policy framework. Time‐varying Granger causality tests accounting for instabilities underscore the above results, namely that inflation uncertainty led to increased inflation uncertainty in the full pre‐inflation targeting period, whereas increased uncertainty led to increased inflation only during the decade preceding inflation targeting. The results heed important policy implications, as it is imperative that inflation is kept low, stable and predictable.

The goal of this paper is to examine the relationship between inflation and inflation uncertainty for Turkey through monthly data spanning the period 2004:01–2019:12. To this end, the paper first builds the inflation uncertainty series using inflation data. Second, it examines the cointegration relationship between inflation and inflation uncertainty. Finally, it searches for causal relationships between inflation and inflation uncertainty. The paper employs econometric methods which explicitly consider structural breaks. After examining the inflation–inflation uncertainty nexus for the whole sample, the analysis also investigates this relationship in two subperiods, i.e., 2004:5–2010:10 and 2010:11:2019:12 considering the change in the monetary policy framework of the Central Bank of the Republic of Turkey (CBRT). The findings provide evidence that there exists unidirectional causality running from inflation to inflation uncertainty for both the whole sample and the second subperiod, while there is no causality between inflation and inflation uncertainty for the first subperiod. Overall, the results show that during the second subperiod (i) when the CBRT tried to achieve not only price stability, but also financial stability and (ii) when the inflation rate is more volatile and higher, the increase in the inflation rate results in an increase in inflation uncertainty.