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Evidence of a nonlinear relationship between inflation and inflation uncertainty: The case of the four little dragons

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  • Chen, Shyh-Wei
  • Shen, Chung-Hua
  • Xie, Zixiong
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    Abstract

    Using a nonlinear flexible regression model for four economies in east Asia, we re-examine two hypotheses in light of the causal relationship between inflation and inflation uncertainty. The first, proposed by Friedman [Friedman, M. (1977). Nobel lecture: Inflation and unemployment. Journal of Political Economy, 85, 451-472], postulates that increased inflation raises inflation uncertainty. Conversely, the second, put forth by Cukierman and Meltzer [Cukierman, A., & Meltzer, A. (1986). a theory of ambiguity, credibility, and inflation under discretion and asymmetric information. Econometrica, 54, 1099-1128], propounds that a high level of inflation uncertainty leads to a higher rate of inflation. Here, except for Hong Kong, overwhelming statistical evidence is found in favor of Friedman's hypothesis. The nonlinearity displays a U-shaped pattern, strongly implying that, indeed, a high rate of inflation or deflation results in high inflation uncertainty. At the same time, however, convincing evidence is found for Cukierman-Meltzer's hypothesis in favor of all four economies. Although Taiwan has an inverted U-shape, Hong Kong, Singapore and South Korea show a positive relation, thus agreeing with Cukierman-Meltzer's hypothesis.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Policy Modeling.

    Volume (Year): 30 (2008)
    Issue (Month): 2 ()
    Pages: 363-376

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    Handle: RePEc:eee:jpolmo:v:30:y:2008:i:2:p:363-376

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    Web page: http://www.elsevier.com/locate/inca/505735

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    1. Arize, Augustine C & Osang, Thomas & Slottje, Daniel J, 2000. "Exchange-Rate Volatility and Foreign Trade: Evidence from Thirteen LDC's," Journal of Business & Economic Statistics, American Statistical Association, vol. 18(1), pages 10-17, January.
    2. Ball, Laurence, 1992. "Why does high inflation raise inflation uncertainty?," Journal of Monetary Economics, Elsevier, vol. 29(3), pages 371-388, June.
    3. Holland, A Steven, 1995. "Inflation and Uncertainty: Tests for Temporal Ordering," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(3), pages 827-37, August.
    4. 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.
    5. Dahl, Christian M. & Gonzalez-Rivera, Gloria, 2003. "Testing for neglected nonlinearity in regression models based on the theory of random fields," Journal of Econometrics, Elsevier, vol. 114(1), pages 141-164, May.
    6. Hamilton, James D, 2001. "A Parametric Approach to Flexible Nonlinear Inference," Econometrica, Econometric Society, vol. 69(3), pages 537-73, May.
    7. Cosimano, Thomas F & Jansen, Dennis W, 1988. "Estimates of the Variance of U.S. Inflation Based upon the ARCH Model: A Comment," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(3), pages 409-21, August.
    8. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
    9. Apergis, Nicholas, 2004. "Inflation, output growth, volatility and causality: evidence from panel data and the G7 countries," Economics Letters, Elsevier, vol. 83(2), pages 185-191, May.
    10. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June.
    11. Hwang, Y., 2001. "Relationship between inflation rate and inflation uncertainty," Economics Letters, Elsevier, vol. 73(2), pages 179-186, November.
    12. 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.
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    Cited by:
    1. Neanidis, Kyriakos C. & Savva, Christos S., 2011. "Nominal uncertainty and inflation: The role of European Union membership," Economics Letters, Elsevier, vol. 112(1), pages 26-30, July.
    2. WenShwo Fang & Stephen M. Miller & Chih-Chuan Yeh, 2007. "Does a Threshold Inflation Rate Exist? Quantile Inferences for Inflation and Its Variability," Working papers 2007-45, University of Connecticut, Department of Economics, revised Jun 2009.

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