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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. Kim, C.J., 1992. "Unobserved-Component Time-Series Models with Markov- Switching Heteroskedasticity: Changes in Regimes and the Link between Inflation Rates and Inflation Uncertainty," Papers 92-1, York (Canada) - Department of Economics.
    2. 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.
    3. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June.
    4. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
    5. 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.
    6. 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.
    7. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
    8. Laurence Ball, 1990. "Why Does High Inflation Raise Inflation Uncertainty?," NBER Working Papers 3224, National Bureau of Economic Research, Inc.
    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, December.
    10. Taylor, Stephen J., 1987. "Forecasting the volatility of currency exchange rates," International Journal of Forecasting, Elsevier, vol. 3(1), pages 159-170.
    11. Ang, Andrew & Bekaert, Geert, 2002. "Regime Switches in Interest Rates," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(2), pages 163-82, April.
    12. 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.
    13. 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.
    14. Martin Evans & Paul Wachtel, 1993. "Inflation regimes and the sources of inflation uncertainty," Proceedings, Federal Reserve Bank of Cleveland, pages 475-520.
    15. Douglas Rivers & Quang Vuong, 2002. "Model selection tests for nonlinear dynamic models," Econometrics Journal, Royal Economic Society, vol. 5(1), pages 1-39, June.
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