The Effect of Inflation on Inflation Uncertainty in the G7 Countries: A Double Threshold GARCH Model

Year 2015, Volume: 7 Issue: 1, 34 - 50, 01.04.2015

Kushal Banik Chowdhury Nityananda Sarkar

https://doi.org/10.33818/ier.278039

Cited By: 6

Abstract

This paper studies the impact of inflation on inflation uncertainty in a modelling framework where both the conditional mean and conditional variance of inflation are regime specific, and the GARCH model for inflation uncertainty is extended by including a lagged inflation term in each regime. Applying this model to the G7 countries with monthly data from 1970 till 2013, it is found that the impact of inflation on inflation uncertainty differs over the regimes in most of the G7 countries. The findings also provide strong empirical support to the well-known Friedman-Ball hypothesis of positive impact of inflation on inflation uncertainty, but only for the high-inflation regime.

Keywords

Inflation, Inflation Uncertainty, Regime Switching Model

References

• Arghyrou, M., C. Martin and C. Milas (2005). Non-linear inflationary dynamics: evidence from the UK. Oxford Economic Papers, 57 (1), 51-69.
• Baillie, R., C.F. Chung and M. Tieslau (1996). Analyzing inflation by the fractionally integrated ARFIMA-GARCH model. Journal of Applied Econometrics, 11 (1) , 23-40.
• Ball, L. (1992). Why does higher inflation raise inflation uncertainty? Journal of Monetary Economics, 29 (3), 371-378.
• Berndt, E.K., B.H. Hall, R.E. Hall and J.A. Hausman (1974). Estimation and inference in nonlinear structural models. Annals of Economic and Social Measurement, 3(4), 103- 116.
• Bhar, R. and S. Hamori (2004). The link between inflation and inflation uncertainty: evidence from G7 countries. Empirical Economics, 29 (4) , 825-853.
• Blinder, A.S. (1982). The anatomy of double-digit inflation in the 1970s. In NBER Chapters, in: Inflation: Causes and Effects, 261-382. National Bureau of Economic Research.
• Bollerslev, T. (1986). Generalised autoregressive conditional heteroskedasticity. Journal of Econometrics, 31 (3), 307-327.
• Bredin, D. and S. Fountas (2005). Macroeconomic uncertainty and macroeconomic performance: Are they related? The Manchester School, 73 (s1), 58-76.
• Brooks, C. (2001). A double-threshold GARCH model for the French/Deutschmark exchange rate. Journal of Forecasting, 20 (2), 135-143.
• Caglayan, M., and A. Filiztekin (2003). Nonlinear impact of inflation on relative price variability. Economics Letters, 79 (2), 213-218.
• Caporale, G.M. and A. Kontonikas (2009). The Euro and inflation uncertainty in the European Monetary Union. Journal of International Money and Finance, 28 (6), 954- 971.
• Cecchetti, S. G. and S. Krause (2001). Financial structure, macroeconomic stability and monetary policy. NBER Working Paper 8354.
• Chan, K. S. and H. Tong (1986). On estimating thresholds in autoregressive models. Journal of time series analysis, 7 (3), 179-190.
• Chang, K.L. (2012). The impacts of regime-switching structures and fat-tailed characteristics on the relationship between inflation and inflation uncertainty. Journal of Macroeconomics, 34 (2), 523-536.
• Chang, K.L. and C.W. He (2010). Does the magnitude of the effect of inflation uncertainty on output growth depend on the level of inflation? Manchester School, 78 (2), 126-148.
• Chen, C.W. (1998). A Bayesian analysis of generalized threshold autoregressive models. Statistics & probability letters, 40 (1), 15-22.
• Chen, C.W. and M.K. So (2006). On a threshold heteroscedastic model. International Journal of Forecasting, 22 (1), 73-89.
• Chen, C.W., T.C. Chiang and M.K. So (2003). Asymmetrical reaction to US stock-return news: evidence from major stock markets based on a double-threshold model. Journal of Economics and Business, 55 (5), 487-502.
• Chen, C.W., M.J. Yang, R. Gerlach and H. Jim Lo (2006). The asymmetric ractions of mean and volatility of stock returns to domestic and international information based on a four- regime double-threshold GARCH model. Physica A: Statistical Mechanics and its Applications, 366 , 401-418.
• Chen, S.W., C.H. Shen and Z. Xie (2008). Evidence of a nonlinear relationship between inflation and inflation uncertainty: The case of the four little dragons. Journal of Policy Modeling, 30 (2) , 363-376.
• Clarida, R., J. Gali and M. Gertler (2000). Monetary policy rules and macroeconomic stability: evidence and some theory. Quarterly Journal of Economics, 115 (1), 147-180.
• Clark, T.E. (2006). Disaggregate evidence on the persistence of consumer price inflation. Journal of Applied Econometrics, 21(5), 563-587.
• Conrad, C. and M. Karanasos (2006). Dual long memory in inflation dynamics across countries of the Euro area and the link between inflation uncertainty and macroeconomic performance. Studies in Nonlinear Dynamics and Econometrics, 9 (4), 1-38.
• Cosimano, T.F. and D.W. Jansen (1988). Estimates of the variance of U.S. inflation based upon the ARCH model. Journal of Money, Credit and Banking, 20 (3), 409-421.
• Daal, E., A. Naka and B. Sanchez (2005). Re-examining inflation and inflation uncertainty in developed and emerging countries. Economics Letters, 89 (2), 180-186.
• DeLong, J.B. (1997). America's peacement inflation. In Reducing Inflation: Motivation and Strategy, ed. C.D. Romer and D.H. Romer, University of Chicago Press, 247-280.
• Dickey, D.A. and W.A. Fuller (1979). Distribution of the estimators for autoregressive time series with a unit root. Journal of the American Statistical Association, 74, 427-431.
• Engle, R.F. (1982). Autoregressive conditional heteroskedasticity with estimates of the variance of UK inflation. Econometrica, 50 (4), 987-1007.
• Engle, R.F. (1983). Estimates of the Variance of US Inflation Based upon the ARCH Model. Journal of Money, Credit and Banking, 15 (3), 286-301.
• Evans, M. and P. Wachtel (1993). Were price changes during the Great Depression anticipated? Evidence from nominal interest rates. Journal of Monetary Economics, 32 (1), 3-34.
• Fischer, S. (1993). The role of macroeconomic factors in growth. Journal of monetary economics, 32 (3), 485-512.
• Fountas, S. (2001). The relationship between inflation and inflation uncertainty in the UK: 1885–1998. Economics Letters, 74 (1), 77-83.
• Fountas, S., A. Ioannidis and M. Karanasos (2004). Inflation, inflation uncertainty and a common European monetary policy. Manchester School, 72 (2), 221-242.
• Fountas, S. and M. Karanasos (2007). Inflation, output growth, and nominal and real uncertainty: empirical evidence for the G7. Journal of International Money and Finance, 26 (2), 229-250.
• Fountas, S., M. Karanasos and M. Karanassou (2000). A GARCH model of inflation and inflation uncertainty with simultaneous feedback. Department of Economics, University of York , Discussion Papers 00/24.
• Fountas, S., M. Karanasos and J. Kim (2002). Inflation and output growth uncertainty and their relationship with inflation and output growth. Economics Letters, 75 (3), 293-301.
• Fountas, S., M. Karanasos and J. Kim (2006). Inflation uncertainty, output growth uncertainty and macroeconomic performance. Oxford Bulletin of Economics and Statistics, 68 (3), 319-343.
• Friedman, M. (1977). Nobel lecture: inflation and unemployment. Journal of Political Economy, 85 (3), 451-472.
• Granger, C.W. and T. Teräsvirta (1993). Modelling non-linear economic relationships. OUP Catalogue.
• Grier, K.B. and M.J. Perry (1998). On inflation and inflation uncertainty in the G7 countries. Journal of International Money and Finance, 17 (4) , 671-689.
• Hamilton, J. (2001). A parametric approach to flexible nonlinear inference. Econometrica, 69 (3), 537-573.
• Hwang, Y. (2001). Relationship between inflation rate and inflation uncertainty. Economics Letters, 73 (2), 179-186.
• Kim, C.J. (1993). Unobserved-component models with Markov switching heteroskedasticity: changes in regime and link between inflation rates and inflation uncertainty. Journal of Business and Economic Statistics, 11 (3), 341-349.
• Kim, C.J. and C.R. Nelson (1999). Has the US economy become more stable? A Bayesian approach based on a Markov-switching model of the business cycle. Review of Economics and Statistics, 81 (4), 608-616.
• Kim, D. and P. Perron (2009). Unit root tests allowing for a break in the trend function at an unknown time under both the null and alternative hypothesis. Journal of Econometrics, 148 (1), 1-13.
• Kontonikas, A. (2004). Inflation and inflation uncertainty in the United Kingdom, evidence from GARCH modelling. Economic Modelling, 21 (3), 525-543.
• Krause, S. (2003). Measuring monetary policy efficiency in European Union countries. Department of Economics, Emory University, Working Paper No. 03-11.
• Lanne, M. (2006). Nonlinear dynamics of interest rate and inflation. Journal of Applied Econometrics, 21 (8), 1157-1168.
• Levin, A. T. and J. Piger (2003). Is inflation persistence intrinsic in industrial economies? Federal Reserve Bank of St. Louis Working Paper 2002-023E.
• Li, C.W. and W.K. Li (1996). On a double-threshold autoregressive heteroscedastic time series model. Journal of Applied Econometrics, 11 (3), 253-274.
• Meltzer, A.H. (2005). Origins of the great inflation. Federal Reserve Bank of St. Louis Review, 87 (2), 145-175.
• Nelson, E. (2005). The great inflation of the seventies: what really happened? The B.E. Journal of Macroeconomics, 5 (1), 1-50.
• Orphanides, A. (2003). The quest for prosperity without inflation. Journal of Monetary Economics, 50 (3), 633-663.
• Perron, P. (1997). Further evidence on breaking trend functions in macroeconomic variables. Journal of Econometrics, 80 (2) , 355-385.
• Perron, P. (1990). Testing for a unit root in a time series with changing mean. Journal of Business & Economic Statistics, 8 (2), 153-162.
• Perron, P. (1989). The great crash, the oil price shock, and the unit root hypothesis. Econometrica, 57 (6), 1361-1401.
• Perron, P. and T.J. Vogelsang (1993). The great crash, the oil price shock and the unit root hypothesis: Erratum. Econometrica, 61 (1), 248-249.
• Perron, P. and T. Yabu (2009). Testing for shifts in trend with an integrated or stationary noise component. Journal of Business and Economic Statistics, 27 (3), 369-396.
• Rapach, D. and M. Wohar (2005). Regime changes in international real interest rates: Are they a monetary phenomenon? Journal of Money, Credit and Banking, 37(5), 887-906.
• Stock, J. H., and Watson, M. W. (1996). Evidence on structural instability in macroeconomic time series relations. Journal of Business & Economic Statistics, 14(1) , 11-30.
• Stock, J.H. and M.W. Watson (2002). Has the business cycle changed and why? NBER Macroeconomics Annual 2002, 17, 159-230.
• Teräsvirtra, T. (1998). Modelling economic relationships with smooth transition regressions. In Handbook of Applied Economic Statistics, ed. A. Ullah and D.E. Giles, 507-552. New York: Marcel Dekker.
• Tong, H. and K.S. Lim (1980). Threshold autoregression, limit cycles and cyclical data. Journal of the Royal Statistical Society, Series B (Methodological), 42 (3), 245-292.
• Ungar, M. and B. Zilberfarb (1993). Inflation and its unpredictability - theory and empirical evidence. Journal of Money, Credit and Banking, 25 (4), 709-720.
• Vogelsang, T.J. and P. Perron (1998). Additional tests for a unit root allowing for a break in the trend function at an unknown time. International Economic Review, 39 (4), 1073- 1100.
• Wilson, B.K. (2006). The links between inflation, inflation uncertainty and output growth: New time series evidence from Japan. Journal of Macroeconomics, 28 (3), 609-620.
• Yang, Y.L. and C.L. Chang (2008). A double-threshold GARCH model of stock market and currency shocks on stock returns. Mathematics and Computers in Simulation, 79(3), 458-474.
• Zivot, E. and D.K. Andrews (1992). Further evidence on the great crash, the oil price shock and the unit root hypothesis. Journal of Business and Economic Statistics, 10 (3) , 251- 270.