Does Inflation Uncertainty Vary with the Level of Inflation?

Overview: The purpose of this study is to test the hypothesis that inflation uncertainty increases at higher levels of inflation. Our analysis is based on the generalized autoregressive conditional heteroscedasticity (GARCH) class of models, which allow the conditional variance of the error term to be time-varying. Since this variance is a proxy for inflation uncertainty, a positive relationship between the conditional variance and inflation would be interpreted as evidence that inflation uncertainty increases with the level of inflation. The difference in the strength of the relationship in the autoregressive and reduced-form models makes it difficult to draw firm conclusions about the relationship between inflation and inflation uncertainty. However, given the extreme information assumptions underlying each model, the true relationship may lie somewhere between the two sets of results. Future research, covering more low-inflation years and based on alternative models of inflation that explicitly incorporate policy-regime uncertainty, might clarify whether inflation uncertainty increases with the level of inflation.

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Format: PDF | Size: 342KB | Date: Aug 1996 | Pages: 54