Modelling Inflation Volatility
AbstractThis paper discusses estimation of US inflation volatility using time varying parameter models, in particular whether it should be modelled as a stationary or random walk stochastic process. Specifying inflation volatility as an unbounded process, as implied by the random walk, conflicts with priors beliefs, yet a stationary process cannot capture the low frequency behaviour commonly observed in estimates of volatility. We therefore propose an alternative model with a change-point process in the volatility that allows for switches between stationary models to capture changes in the level and dynamics over the past forty years. To accommodate the stationarity restriction, we develop a new representation that is equivalent to our model but is computationally more efficient. All models produce effectively identical estimates of volatility, but the change-point model provides more information on the level and persistence of volatility and the probabilities of changes. For example, we find a few well defined switches in the volatility process and, interestingly, these switches line up well with economic slowdowns or changes of the Federal Reserve Chair.
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Bibliographic InfoPaper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2014-21.
Length: 38 pages
Date of creation: Feb 2014
Date of revision:
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Inflation volatility; monetary policy; time varying parameter model; Bayesian estimation; Change-point model;
Find related papers by JEL classification:
- C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2014-03-08 (All new papers)
- NEP-CBA-2014-03-08 (Central Banking)
- NEP-ECM-2014-03-08 (Econometrics)
- NEP-MAC-2014-03-08 (Macroeconomics)
- NEP-MON-2014-03-08 (Monetary Economics)
- NEP-ORE-2014-03-08 (Operations Research)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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