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Regime-shifts and post-float inflation dynamics of Australia

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  • Karunaratne, Neil Dias
  • Bhar, Ramprasad
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    Abstract

    Australia's inflation rate and inflation uncertainty during the post-float era 1983Q3-2006Q4 have acted as important barometers of Australia's macroeconomic performance. The conceptualization and measurement of the nexus between inflation and inflation uncertainty is subject to complex dynamics. We use the Markov regime switching heteroscedasticity (MRSH) model to capture long-run stochastic trend and short-run noisy components. This allows us to conclude that in post-float Australia the results deviate significantly from the mainstream Friedman paradigm on inflation and its uncertainty. We also critically review the plausibility of rival paradigms e.g. Keynesian-Mundell-Fleming, Friedman-Ball, Cukierman-Meltzer and Holland, explaining this paradoxical behavior. The analyses presented here provide valuable insights to policymakers grappling with the challenge of designing monetary policy to combat the adverse effects of inflation and inflation uncertainty for Australia emerging out of the global financial crisis.

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    Bibliographic Info

    Article provided by Elsevier in its journal Economic Modelling.

    Volume (Year): 28 (2011)
    Issue (Month): 4 (July)
    Pages: 1941-1949

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    Handle: RePEc:eee:ecmode:v:28:y:2011:i:4:p:1941-1949

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    Web page: http://www.elsevier.com/locate/inca/30411

    Related research

    Keywords: Markov Regime-Switching Heteroscedasticity (MRSH) Inflation uncertainty Friedman paradigm Keynesian-Mundell-Fleming model Intertemporal optimization;

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    1. Grier, Kevin B. & Perry, Mark J., 1998. "On inflation and inflation uncertainty in the G7 countries," Journal of International Money and Finance, Elsevier, vol. 17(4), pages 671-689, August.
    2. Ramaprasad Bhar & Shigeyuki Hamori, 2004. "The link between inflation and inflation uncertainty: Evidence from G7 countries," Empirical Economics, Springer, vol. 29(4), pages 825-853, December.
    3. Brunner, Allan D & Simon, David P, 1996. "Excess Returns and Risk at the Long End of the Treasury Market: An EGARCH-M Approach," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 19(3), pages 443-57, Fall.
    4. Lastrapes, William D, 1989. "Exchange Rate Volatility and U.S. Monetary Policy: An ARCH Application," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 21(1), pages 66-77, February.
    5. Andrew Ang & Geert Bekaert, 1998. "Regime Switches in Interest Rates," NBER Working Papers 6508, National Bureau of Economic Research, Inc.
    6. Robert J. Barro & David B. Gordon, 1983. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
    7. Ball, Laurence, 1992. "Why does high inflation raise inflation uncertainty?," Journal of Monetary Economics, Elsevier, vol. 29(3), pages 371-388, June.
    8. Douglas Rivers & Quang Vuong, 2002. "Model selection tests for nonlinear dynamic models," Econometrics Journal, Royal Economic Society, vol. 5(1), pages 1-39, June.
    9. Chang-Jin Kim & Charles R. Nelson, 1999. "State-Space Models with Regime Switching: Classical and Gibbs-Sampling Approaches with Applications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262112388.
    10. Cukierman, Alex & Meltzer, Allan H, 1986. "A Theory of Ambiguity, Credibility, and Inflation under Discretion and Asymmetric Information," Econometrica, Econometric Society, vol. 54(5), pages 1099-1128, September.
    11. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June.
    12. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
    13. Martin Evans & Paul Wachtel, 1993. "Inflation regimes and the sources of inflation uncertainty," Proceedings, Federal Reserve Bank of Cleveland, pages 475-520.
    14. Taylor, Stephen J., 1987. "Forecasting the volatility of currency exchange rates," International Journal of Forecasting, Elsevier, vol. 3(1), pages 159-170.
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