Effect Of Inflation Uncertainty Research Articles

Effects of inflation uncertainty and exchange rate volatility on money demand in Pakistan: Bayesian econometric analysis

AbstractThe study explores determinants of money demand (M2) in a developing economy of Pakistan using annual data ranging 1976–2017. The study contributes by two ways. Firstly, it specifically examines the potential impact of exchange rate volatility and inflation uncertainty along with conventional determinants on money demand in Pakistan. Secondly, Bayesian Statistical inference is employed and the estimates are interpreted along with highest posterior density intervals (HPDI) with probability statements in order to cope with the issue of the instability of parameters. The analysis explores the positive impact of real income as well as share prices and the negative effect of interest rate on money demand as predicted by theory and earlier findings. Significant negative estimate of exchange rate shows that substitution effect overcomes wealth effect during exchange rate variations. But magnitude of exchange rate elasticity seems to depend upon strength of depreciation rate and/or future expectations, which may be considered an important research question for future work. Insignificance of exchange rate volatility for money demand in Pakistan is found which requires further research as to know about the behaviour of wealth effect and expectation effect during forex market uncertainty. Most importantly, inflation uncertainty is found to be a potential determinant of money demand in Pakistan. Rising uncertainty of inflation rate seems to have direct effects on precautionary and transaction motives of the demand for money. Findings of this study provides useful insights for policymaking in Pakistan as well as in other developing economies by suggesting inflation uncertainty as the potential determinant of money demand. Finally, Bayesian estimates along with HPDI estimates provide new information about the effects and particularly about the possible range of elasticities.

The effect of economic uncertainty on narrow money demand and its stability in New Zealand: An empirical investigation

The main objective of this paper is to investigate whether economic uncertainty affects narrow money demand in New Zealand and whether the specified money-demand function remains stable over time. New Zealand adopted inflation-targeting in the early 1990s by discarding monetary-targeting or any other strategy of monetary policy for price stability on the grounds that instability in the narrow money-demand function might sever the relationship among money, output, prices, interest rates, and exchange rates, as the classical monetary theory suggests. This paper specifies an augmented money-demand function for an open economy that includes economic uncertainty and inflation volatility as two additional determinants of money demand. Quarterly data for New Zealand for the period 1995Q1–2017Q4 is used to determine whether these variables remain significant in an augmented money-demand function in this country. The empirical results, obtained by the autoregressive distributed lag (ARDL) approach to cointegration, suggest that there exists a cointegral relationship among variables in the specified model and that economic uncertainty negatively affects narrow money demand in New Zealand. Further, the empirical results, obtained by the non-linear ARDL (NARDL) approach, suggest that economic uncertainty affects narrow money demand asymmetrically. An increase in economic uncertainty lowers narrow money demand, while a decrease in economic uncertainty does not increase – and​ instead seems to decrease – narrow money demand. Unlike with economic uncertainty, an increase in inflation volatility, which represents inflation uncertainty, increases narrow money demand. Although it is not conclusively established in this paper, the effect of inflation uncertainty on narrow money-demand seems symmetric. The narrow money-demand function is found in this paper to have remained stable irrespective of whether the model is estimated by the ARDL or NARDL approach. This paper draws the conclusion that the abandonment of money in the formulation of monetary policy strategy, such as inflation-targeting in New Zealand, cannot be justified on the grounds of instability in the narrow money-demand function.

Regime‐dependent effects of uncertainty on inflation and output growth: evidence from the United Kingdom and the United States

AbstractEmploying a bivariate regime switching model, this paper attempts to examine the regime‐dependent effects of inflation uncertainty and output growth uncertainty on inflation and output growth. Using monthly data of the United Kingdom and the United States, we provide evidence that both nominal and real uncertainty exert regime‐dependent impacts on inflation. Furthermore, in case of both the countries, inflation uncertainty has adverse impact on output growth mainly during the period of economic contraction. Also, for these two countries, it can be argued that higher real uncertainty significantly reduces output growth only in their respective low output growth regimes.

Effect of inflation uncertainty on price dispersion in Iran

This paper studies the inflation relationship analysis and inflation uncertainty with relative price’ dispersion in Iran by using the ordinary minimum squares method, during monthly data 1991:4-2012:12. In this paper, we used the GARCH technique in order to modeling and measuring the inflation uncertainty variable. The results show that inflation uncertainty increasing leads to increased relative price dispersion. Also unexpected inflation regardless of being positive or negative increases the relative price dispersion considerably, but the unexpected inflation decomposition to two positive and negative components and lack of considering them in the equation showed that each component is in a high significant level and cannot be considered for symmetric effect of positive or negative unexpected inflation. Corporations change their price against the positive unexpected inflation alternatively in responding to the inflation shocks and consequently the price will be fluctuated for reaching the balance strictly, therefore positive unexpected inflation cases have been increasing in relative price dispersion. In the other hand, corporations have no tendency for changing the goods’ price against the negative unexpected inflation. Also according to the results, inflation variable coefficient is significant from the statistical viewpoint and this means that this variable increases the relative dispersion considerably.

Inflation and inflation uncertainty in China

ABSTRACTThe study examines the relationship between inflation and inflation uncertainty in China using Generalized Autoregressive Conditional Heteroscedasticity model. Particularly, this link is investigated in China’s urban and rural sectors, motivated by the substantial urban–rural divide. The results provide strong statistical supportive evidence that higher inflation raises inflation uncertainty. On the other hand, evidence on the effect of inflation uncertainty on inflation is mixed depending on the sample periods and areas examined. The understanding of inflation-uncertainty nexus in China could provide implications to policymakers in the adoption of monetary policies.

The effects of inflation uncertainty on interest rates: a nonlinear approach

In this article, we investigate the effects of inflation variability on short-term interest rates within a nonlinear smooth transition regression framework. The test results suggest that only the conditional mean of the inflation is a nonlinear process whereas the conditional variance is time variant but linear. Using the square root of conditional variance as a proxy for inflation risk, we estimate Fisher equation augmented with inflation risk. Although the estimated Fisher equations suggest that inflation risk reduces short-term interest rates, we find that the effects of inflation risk on interest rates are regime-dependent. Particularly, we find that the negative effects of inflation variability on nominal rates are greater in low-inflationary regimes when compared to high-inflationary regimes. On the other hand, it is found that both inflation and inflation uncertainty raise the expected inflation effect.

Inflation and inflation uncertainty in Turkey

This article investigates the relationship between inflation and inflation uncertainty, and the impact of monetary policy on this relationship using monthly Turkish inflation data over January 1984 to–October 2005. The results from various types of GARCH-M models indicate that higher inflation rates lead to greater inflation uncertainty. On the other hand, the effect of inflation uncertainty on inflation is found to be negative due to stabilization motives’ dominating the opportunistic incentives of monetary authorities. We find strong evidence to support the view that inflation-oriented monetary policy has power to reduce the inflation persistence and eliminate uncertainty.

The effects of inflation uncertainty: some international evidence

PurposeThe purpose of this paper is to examine the effects of inflation uncertainty on real economic activity using data from four industrialised countries.Design/methodology/approachThe paper uses the econometric framework developed by Elder in the context of a multivariate framework in which a structural vector autoregression (VAR) is modified to accommodate multivariate GARCH‐in‐mean (MGARCH‐M) errors. It calculates the impulse response functions for the multivariate GARCH(1,1)‐in‐mean VAR in order to see whether the specification captures the fundamental dynamics.FindingsThe results show that inflation uncertainty has differential effects on output growth across these countries.Originality/valueIn the context of multivariate GARCH(1,1)‐in‐mean VAR, this paper uses a non‐recursive identification scheme and separate identification for the large and small economies.

The effects of exchange rate uncertainty on exports

We investigate the effects of exchange rate uncertainty on exports in the context of a multivariate framework in which a structural open economy vector autoregression is modified to accommodate multivariate GARCH-in-Mean errors, as detailed in Elder (Elder, J., 2004. Another perspective on the effects of inflation uncertainty. Journal of Money, Credit, and Banking 36, 912–928). Our measure of exchange rate uncertainty is the conditional standard deviation of the forecast error of the change in the exchange rate. We isolate the effects of exchange rate uncertainty on exports and also analyze how accounting for exchange rate uncertainty affects the response of exports to exchange rate shocks. We estimate the model using aggregate monthly data for the United States, over the flexible exchange rate period (since 1973). We use full information maximum likelihood estimation procedures and find that exchange rate uncertainty has a negative and significant effect on US exports. We also find that accounting for exchange rate uncertainty tends to strengthen the dynamic response of exports to shocks in the exchange rate and that exports respond asymmetrically to positive and negative exchange rate shocks of equal magnitude.

The Relationship between Inflation and Inflation Uncertainty in Emerging Market Economies

A standard Generalized Autoregressive Conditional Heteroskedastic (q,v) model is employed to construct a measure of monthly inflation uncertainty in 12 emerging market economies, and the relationship between inflation and inflation uncertainty is examined using Granger‐causality tests. The results suggest that higher inflation rates increased inflation uncertainty in all the economies, providing strong support for the Friedman hypothesis. The evidence on the effect of inflation uncertainty on average monthly inflation is more mixed, with increased inflation uncertainty leading to lower average inflation in Colombia, Israel, Mexico, and Turkey, consistent with the Holland hypothesis, but to higher average inflation in Hungary, Indonesia, and Korea, consistent with the hypothesis of Cukierman and Meltzer.

Inflation, output growth, and nominal and real uncertainty: Empirical evidence for the G7

We use univariate GARCH models of inflation and output growth and monthly data for the G7 covering the 1957–2000 period to test for the causal effect of real and nominal macroeconomic uncertainty on inflation and output growth, and the effect of inflation on inflation uncertainty. Our evidence supports a number of important conclusions. First, inflation is a positive determinant of uncertainty about inflation. Second, output growth uncertainty is a positive determinant of the output growth rate. Third, there is mixed evidence regarding the effect of inflation uncertainty on inflation and output growth. Hence, uncertainty about the inflation rate is not necessarily detrimental to economic growth. Finally, there is not much evidence supporting the hypothesis that output uncertainty raises inflation.

MACROECONOMIC UNCERTAINTY AND MACROECONOMIC PERFORMANCE: ARE THEY RELATED?

We use a very general bivariate generalized autoregressive conditional heteroskedasticity‐in‐mean model and G7 monthly data covering the 1957–2003 period to test for the impact of real and nominal macroeconomic uncertainty on inflation and output growth. Our evidence supports a number of important conclusions. First, in most countries output growth uncertainty is a positive determinant of the output growth rate. Second, there is mixed evidence regarding the effect of inflation uncertainty on inflation and output growth. Hence, contrary to popular belief, uncertainty about the inflation rate is not necessarily detrimental to economic growth but in some cases it may also enhance growth. Finally, there is mixed evidence on the effect of output uncertainty on inflation. In sum, our results indicate that macroeconomic uncertainty may even improve macroeconomic performance.

On the real effects of inflation and inflation uncertainty in Mexico

We estimate an augmented multivariate GARCH-M model of inflation and output growth for Mexico at business cycle frequencies. The main findings are: (1) inflation uncertainty has a negative and significant effect on growth; (2) once the effect of inflation uncertainty is accounted for, lagged inflation does not have a direct negative effect on output growth; (3) However as predicted by Friedman and Ball, higher average inflation raises inflation uncertainty, and the overall net effect of average inflation on output growth in Mexico is negative. That is, average inflation is harmful to Mexican growth due to its impact on inflation uncertainty. (4) The Mexican Presidential election cycle significantly raises inflation uncertainty both during the year of the election and the year following the election which has correspondingly negative effects on output growth.

Inflation, inflation uncertainty, and monetary policy in Turkey: 1960–1998

The authors constructed a time series of monthly inflation uncertainty in Turkey from 1960 to 1998 using GARCH models and investigated the link between inflation and inflation uncertainty using Granger tests. The authors found strong statistical support that inflation significantly raised inflation uncertainty in Turkey over the full sample period and three subsamples. The evidence on the effect of inflation uncertainty on average inflation is mixed and depends on the time period examined. An analysis of the political conditions and the record of macroeconomic policy making in Turkey between 1960 and 1998 reveal institutional and political factors that can help explain the empirical results.

A note on the demand for labor by firms and the Phillips curve phenomenon

This paper derives microeconomic implications of an increase in inflation uncertainty for a firm's demand for capital and labor resources. The concern for this topic is motivated by an interest in the effect of inflation uncertainty on the demand for labor and especially the Phillips curve. The basic idea is that an increase in the actual inflation rate increases inflation uncertainty with respect to the rental price of capital relative to that of labor, which in turn increases the demand for labor, both absolutely and relative to the capital stock. The result is a decline in unemployment.

Inflation Uncertainty and Real Economic Activity: An Alternative Approach

A bstracct-Increased uncertainty about inflation is shown to encourage inflation hedging which, in turn, reduces the macroeconomic costs of that uncertainty. Portfolio theory and empirical evidence support the contention that only the portion of inflation volatility that cannot be hedged has real economic effects. Additional empinrcal results suggest that: (i) increased inflation volatility in the early seventies was eventually followed by portfolio reallocations that allowed for greatly improved inflation hedging, and (ii) the deletenrous effect of inflation uncertainty on real economic activity shown in previouis studies is significantly smaller after 1975.

Real Interest, Money Surprises, Anticipated Inflation and Fiscal Deficits

THE hypothesis attributed to Fisher (1930) and more recently the innovative investigation by Fama (1975) have predisposed many economists to treat the expected rate of interest as a constant. At the very least, as a magnitude, the expected interest rate is appealingly viewed as being independent of monetary phenomena. The late 1970s and early 1980s have produced events which force reevaluation of the maintained hypothesis of constancy of the expected rate (hereafter referred to as the real rate). For example, from December 1980 to June 1981 the expected rate of inflation fell by 165 basis points from an annual rate of 10.51 % to an annual rate of 8.86%.' Over the same period 3 month Treasury bill rates continued to remain largely between 14% and 16% with average yields of 15.02% in December 1980 and 14.95% in June 1981. In order to reconcile such facts, one must either believe that security markets no longer fully reflect changes in anticipated inflation in nominal market rates, or that a large drop in anticipated inflation which is not accompanied by a drop of similar magnitude in nominal interest rates, is due to an offsetting rise in the rate.2 Statistical investigations regarding the possibility of movements in the rate have appeared with increasing frequency since publication of Fama's (1975) provocative article.3 Nelson and Schwert (1977) argued that Fama's test of the joint hypothesis of market efficiency and constancy of the rate was not sufficiently powerful and after applying more powerful tests concluded that the data permitted rejection of the hypothesis of constancy of the rate. Other investigations including those by Carlson (1977), Garbade and Wachtel (1978) and Levi and Makin (1979) have rejected the hypothesis of constancy of the rate while tending to support the hypothesis that market interest rates include an efficient inflationary premium. Tanzi (1980) has, along with others, emphasized the role of taxes in interest rate determination. More recently investigators have moved from merely testing the hypothesis of constancy of the rate to searching for an explanation for the rate movements suggested by a large body of statistical evidence. Mishkin (1981) and Fama and Gibbons (1982) have investigated the relationship between the rate and anticipated inflation suggested by Mundell (1963) and Tobin (1965).4 Levi and Makin (1979, 1981), Hartman (1981) and Hartman and Makin (1982) have considered effects of inflation uncertainty on the rate. Dwyer (1981) has found that the rate is independent of predictable changes in the supply. This paper derives a Fisher-type interest rate equation from a structural model similar to that employed by Sargent (1973) for other purposes. The primary differences involve inclusion of a government sector and a simple open economy specification along with introduction of a role for Received for publication February 22, 1982. Revision accepted for publication September 3, 1982. *University of Washington and National Bureau of Economic Research. This work was supported by the National Science Foundation under (irant No. SES-8112687. I would like to thank without implicating Charles Nelson, Richard Hartman and especially Andrew Criswell for excellent help in estimating the equations. An earlier version of this paper was presented at an FMME Conference at NBER where many useful suggestions were provided. ' This figure is based on Livingston survey data for 6 month horizon expectations regarding the consumer price index (CPI). The 12 month horizon figure for CPI also indicated a drop of 165 basis points while 6 and 12 month horizon numbers for WPI indicated drops of 192 and 174 basis points, respectively. Updated Livingston survey data are now compiled by the Federal Reserve Bank of Philadelphia. 2Summers (1982) has argued that nominal interest rates do not adjust by the full amount implied by the Fisher hypothesis modified to allow for marginal tax rates on interest earnings. His results based on both preand post-World War II data arise from equations which employ actual inflation rates in place of anticipated inflation and which generally do not include variables to control for movements in the expected rate. 3Even well before the investigations discussed here Irving Fisher himself reported, based on an investigation of market interest rates during the late 19th and early 20th centuries in London, New York, Berlin, Calcutta and Tokyo, that ' the rate of interest in terms of commodities is from seven to thirteen times as variable as the market rate of interest expressed in terms of money (Fisher (1930), p. 415). 4 Mishkin (198 1) found a significant negative impact upon the rate of a lagged actual (CPI) inflation rate taken as a proxy for anticipated inflation. An ARIMA (0, 1, 1) inflation model with a seasonal MAI term also provided an expected inflation proxy with a significant negative impact on the rate. Mishkin (1982) is discussed below.

The effects of inflation uncertainty and supply shocks on real interest rates

Abstract Increased inflation uncertainty and negative supply shocks have been suggested separately as causes of the 1970s decline in real interest rates. When both factors appear in empirical interest rate models, supply forces exert a statistically significant impact on real rates while the effect of inflation uncertainty is insignificant.

The effect of inflation uncertainty on ‘crowding out’

It is widely recognized that expansionary fiscal policy can crowd out private investment. The degree of crowding out depends in part on the degree of substitutability between public and private securities. In this paper, we look at how inflation uncertainty affects this substitutability and the degree of crowding out. Depending on the covariance of the return of private securities with the rate of inflation, the degree of substitutability, and thus the level of crowding out, will diminish as inflation uncertainty increases. Indeed, an increase in government debt may actually decrease the real return required on private securities, leading to “negative” crowding out.

The determinants of the return on index bonds

The investor holding an index-linked bond is guaranteed a given real income irrespective of the prevailing inflation rate. The holding-period return (HPR) on such a bond should, therefore adjust to realized inflation; this is the firsthypothesis tested. The value of the bond may also change due to anticipated changes in the real interest rate which should themselves be related to uncertainty about future inflation; hence HPRs on linked bonds may vary with inflation uncertainty (second hypothesis). Furthermore, for bonds with long periods of time to maturity the effect of uncertainty about future inflation rates may be rather small so that as we approach maturity, the effect of inflation uncertainty should increase (third hypothesis). These three hypotheses are tested on a sample of eight Israeli index-linked bonds with maturities three months apart. The first hypothesis is supported by the data but the last two are not.