THE RELATION BETWEEN THE RATE AND VARIABILITY OF INFLATION: FURTHER COMMENTS

Abstract

SUMMARY This paper is an empirical investigation of the hypothesis that there exists a positive relationship between the inflation rate and its variability. The hypothesis is tested for a sample of eighteen industrial countries for the period 1949-1970. In contrast to most previous studies, policy makers are allowed to revise their desired inflation rate by calculating a six-year moving average. The homogeniety assumption across countries is relaxed and the relationship between the average inflation rate and its variability over time is examined within each country. In addition, the argument that government financial policy is responsible for the variability of the inflation rate is reexamined in the context of a fixed-exchange-rate open economy; an alternative source of inflation variability is proposed-international inflation. A procedure that separates out the influence of the world inflation rate is developed and the relationship between the average inflation rate and its measure of variability attributable to domestic government financial policy is examined. The findings of this study provide less pervasive support than previous studies of the existence of a positive relationships between the inflation rate and its variability. Moreover, the positive causality uncovered might be due more to international inflation than to the actions of domestic financial authorities.