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Is the Relationship Between Inflation and its Uncertainty Linear?

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Author Info
Menelaos Karanasosa ()
Stefanie Schurer ()
Abstract

We use parametric power ARCH models of the conditional variance of inflation to model the relationship between inflation and its uncertainty using monthly data for Germany, the Netherlands and Sweden over a period ranging from 1962 to 2004. For all three countries inflation significantly raises inflation uncertainty as predicted by Friedman. Increased uncertainty affects inflation in all countries but not in the same manner. For Sweden we find a negative impact in accordance with the Holland hypothesis, whereas for Germany and the Netherlands we find the opposite in support of the Cukierman-Meltzer hypothesis. In a sensitivity analysis we show that an arbitrary choice of the heteroskedasticity parameter influences this relationship significantly.

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Publisher Info
Paper provided by Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen in its series Ruhr Economic Papers with number 0018.

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Length: 29 pages
Date of creation: Jan 2007
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Handle: RePEc:rwi:repape:0018

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Related research
Keywords: GARCH-in-mean Inflation Level e¤ect Nominal uncertainty Power transformation.

Find related papers by JEL classification:
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

References listed on IDEAS
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  1. Brunner, Allan D & Hess, Gregory D, 1993. "Are Higher Levels of Inflation Less Predictable? A State-Dependent Conditional Heteroscedasticity Approach," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(2), pages 187-97, April.
    Other versions:
  2. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December. [Downloadable!] (restricted)
    Other versions:
  3. 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. [Downloadable!] (restricted)
  4. Fabio Fornari & Antonio Mele, 2001. "Recovering the Probability Density Function of Asset Prices Using GARCH as Diffusion Approximations," Temi di discussione (Economic working papers) 396, Bank of Italy, Economic Research Department. [Downloadable!]
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  5. Karanasos, Menelaos & Kim, Jinki, 2006. "A re-examination of the asymmetric power ARCH model," Journal of Empirical Finance, Elsevier, vol. 13(1), pages 113-128, January. [Downloadable!] (restricted)
  6. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June. [Downloadable!] (restricted)
  7. Christian Conrad & Menelaos Karanasos, 2005. "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 & Econometrics, Berkeley Electronic Press, vol. 9(4), pages 1147-1147. [Downloadable!] (restricted)
  8. 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. [Downloadable!] (restricted)
  9. Conrad, C. & Karanasos, M., 2005. "On the inflation-uncertainty hypothesis in the USA, Japan and the UK: a dual long memory approach," Japan and the World Economy, Elsevier, vol. 17(3), pages 327-343, August. [Downloadable!] (restricted)
  10. Brooks, Robert D. & Faff, Robert W. & McKenzie, Michael D. & Mitchell, Heather, 2000. "A multi-country study of power ARCH models and national stock market returns," Journal of International Money and Finance, Elsevier, vol. 19(3), pages 377-397, June. [Downloadable!] (restricted)
  11. Stilianos Fountas & Menelaos Karanasos & Jinki Kim, 2006. "Inflation Uncertainty, Output Growth Uncertainty and Macroeconomic Performance," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 68(3), pages 319-343, 06. [Downloadable!] (restricted)
  12. Ding, Zhuanxin & Granger, Clive W. J. & Engle, Robert F., 1993. "A long memory property of stock market returns and a new model," Journal of Empirical Finance, Elsevier, vol. 1(1), pages 83-106, June. [Downloadable!] (restricted)
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  13. Kevin B. Grier & Mark J. Perry, 2000. "The effects of real and nominal uncertainty on inflation and output growth: some garch-m evidence," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(1), pages 45-58. [Downloadable!]
  14. Ball, Laurence, 1992. "Why does high inflation raise inflation uncertainty?," Journal of Monetary Economics, Elsevier, vol. 29(3), pages 371-388, June. [Downloadable!] (restricted)
  15. Fabio Fornari & Antonio Mele, 1997. "Weak convergence and distributional assumptions for a general class of nonliner arch models," Econometric Reviews, Taylor and Francis Journals, vol. 16(2), pages 205-227. [Downloadable!] (restricted)
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