Hostname: page-component-78c5997874-t5tsf Total loading time: 0 Render date: 2024-11-08T08:39:07.778Z Has data issue: false hasContentIssue false
  • English
  • Français

INFLATION TARGETING UNDER INFLATION UNCERTAINTY—MULTI-ECONOMY EVIDENCE FROM A STOCHASTIC VOLATILITY MODEL

Published online by Cambridge University Press:  29 December 2020

Matthias Hartmann ,
Helmut Herwartz  and
Maren Ulm
Matthias Hartmann
Affiliation:
Center for European Studies, University of Milan
Helmut Herwartz
Affiliation:
Georg-August-University Göttingen
Maren Ulm*
Affiliation:
Georg-August-University Göttingen
*
Address correspondence to: Maren Ulm, Department of Economics, Georg-August-University Göttingen, Humboldtallee 3, 37073Göttingen, Germany. e-mail: [email protected], [email protected].
Get access Rights & Permissions [Opens in a new window]

Abstract

One of the most important advantages of an inflation target is that it helps to reduce uncertainty about future inflation. However, this confidence may be undermined if actual inflation continuously deviates from the target level. We examine how inflation uncertainty relates to the presence of an inflation target and deviations of inflation from the targeted level. Inflation uncertainty is quantified by means of an unobserved components stochastic volatility model that allows to distinguish between permanent and transitory inflation uncertainty. While long-term inflation appears largely stable in most economies, the short-term inflation uncertainty is found to be time-varying. Most notably, short-term inflation uncertainty is high if inflation rates are below the target level. This is particularly relevant for economies which are currently confronted with the presence of persistently low-inflation rates. Our findings suggest that announcing higher inflation targets as it is currently discussed may be costly in terms of provoking higher inflation uncertainty.

Keywords

Inflation TargetingInflation UncertaintyStochastic VolatilityIdentification through Heteroscedasticity
Type
Articles
Information
Macroeconomic Dynamics , Volume 26 , Issue 5 , July 2022 , pp. 1302 - 1337
Copyright
© Cambridge University Press 2020

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

We thank Geert Bekaert, Benjamin Born, Zeno Enders, Jan-Oliver Menz, Elmar Mertens and Henning Weber, the editor William A. Barnett, and two anonymous referees as well as conference participants at the SMYE 2017 Halle for helpful comments. Financial support from the Fritz-Thyssen Foundation is gratefully acknowledged.

References

Ball, L. M. (1992) Why does high inflation raise inflation uncertainty. Journal of Monetary Economics 29, 371–388.CrossRefGoogle Scholar
Ball, L. M. and Cecchetti, S. G. (1990) Inflation and uncertainty at short and long horizons. Brookings Papers on Economic Activity 1, 215–254.CrossRefGoogle Scholar
Batchelor, R. and Orr, A. (1991) Inflation uncertainty, inflationary shocks and the credibility of counterinflation policy. European Economic Review 35, 1385–1397.CrossRefGoogle Scholar
Baum, C. F. and Schaffer, M. E. (2012) IVREG2H: Stata module to perform instrumental variables estimation using heteroskedasticity-based instruments. Statistical Software Components, Boston College Department of Economics.Google Scholar
Beechey, M., Johannsen, B. and Levin, A. (2011) Are long-run inflation expectations anchored more firmly in the Euro Area than in the United States? American Economic Journal: Macroeconomics 3, 104–129.Google Scholar
Berger, T., Everaert, G. and Vierke, H. (2016) Testing for time variation in an unobserved components model for the U.S. economy. Journal of Economic Dynamics and Control 69, 179–208.CrossRefGoogle Scholar
Berger, T. and Grabert, S. (2018) International output and inflation uncertainty and their impact on countries’ macroeconomic performance. Evidence from a dynamic factor GARCH-in-mean model. Macroeconomic Dynamics 22, 1113–1133.CrossRefGoogle Scholar
Bernanke, B. S., Laubach, T., Mishkin, F. S. and Posen, A. S. (1999) Inflation Targeting: Lessons from International Experience. Princeton University Press.Google Scholar
Bloom, N. (2009) The impact of uncertainty shocks. Econometrica 77, 623–685.Google Scholar
Caporale, G. M. and Kontonikas, A. (2009) The Euro and inflation uncertainty in the European Monetary Union. Journal of International Money and Finance 28, 954–971.CrossRefGoogle Scholar
Carter, C. K. and Kohn, R. (1994) On Gibbs sampling for state-space models. Biometrika 81, 541–553.CrossRefGoogle Scholar
Chan, J. (2016) Specification tests for time-varying parameter models with stochastic volatility. Econometric Reviews 37, 807–823.CrossRefGoogle Scholar
Ciccarelli, M. and Mojon, B. (2010) Global inflation. The Review of Economics and Statistics 92, 524–535.CrossRefGoogle Scholar
Clements, M. P. and Galvao, A. B. (2014) Measuring Macroeconomic Uncertainty: U.S. Inflation and Output Growth. Working Paper.CrossRefGoogle Scholar
Cogley, T. and Sbordone, A. M. (2008) Trend inflation, indexation, and inflation persistence in the New Keynesian Phillips curve. The American Economic Review 98, 2101–2126.CrossRefGoogle Scholar
Coibion, O. and Gorodnichenko, Y. (2012) What can survey forecasts tell us about information rigidities? Journal of Political Economy 120, 116–159.CrossRefGoogle Scholar
Conrad, C. and Karanasos, M. (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 and Econometrics 9, Article 5.Google Scholar
Cornand, C. and M’baye, C. K. (2018) Does inflation targeting matter? An experimental investigation. Macroeconomic Dynamics 22, 362–401.CrossRefGoogle Scholar
Dovern, J., Fritsche, U. and Slacalek, J. (2012) Disagreement among forecasters in G7 countries. Review of Economics and Statistics 94, 1081–1096.CrossRefGoogle Scholar
Eisenstat, E., Chan, J. and Strachan, R. W. (2016) Stochastic model specification search for time-varying parameter VARS. Econometric Reviews 35, 1638–1665.CrossRefGoogle Scholar
Engle, R., Ghysels, E. and Sohn, B. (2013) Stock market volatility and macroeconomic fundamentals. The Review of Economics and Statistics 95, 776–797.CrossRefGoogle Scholar
Fraga, A., Goldfajn, I. and Minella, A. (2003) Inflation targeting in emerging market economies. Technical Report 18. National Bureau of Economic Research.CrossRefGoogle Scholar
Friedman, M. (1977) Nobel lecture: Inflation and unemployment. Journal of Political Economy 85, 451–472.CrossRefGoogle Scholar
Frühwirth-Schnatter, S. and Wagner, H. (2010) Stochastic model specification search for Gaussian and partial non-Gaussian state space models. Journal of Econometrics 154, 85–100.CrossRefGoogle Scholar
Giordani, P. and Söderlind, P. (2003) Inflation forecast uncertainty. European Economic Review 47, 1037–1059.CrossRefGoogle Scholar
Gonçalves, C. E. S. and Salles, J. M. (2008) Inflation targeting in emerging economies: What do the data say? Journal of Development Economics 85, 312–318.CrossRefGoogle Scholar
Grassi, S. and Proietti, T. (2014) Characterising economic trends by Bayesian stochastic model specification search. Computational Statistics and Data Analysis 71, 359–374.CrossRefGoogle Scholar
Gregoriou, A. and Kontonikas, A. (2009) Modeling the behaviour of inflation deviations from the target. Economic Modelling 26, 90–95.CrossRefGoogle Scholar
Grier, K. B. and Perry, M. J. (1998) On inflation and inflation uncertainty in the G7 countries. Journal of International Money and Finance 17, 671–689.CrossRefGoogle Scholar
Hammond, G. (ed.) (2012) State of the art of inflation targeting - 2012. Number 29 in Center for Central Bank Studies Handbook, Bank of England.Google Scholar
Hartmann, M. and Herwartz, H. (2012) Causal relations between inflation and inflation uncertainty-cross sectional evidence in favour of the Friedman-Ball hypothesis. Economics Letters 115, 144–147.CrossRefGoogle Scholar
Hartmann, M. and Herwartz, H. (2014) Did the introduction of the Euro have an impact on inflation uncertainty? An empirical assessment. Macroeconomic Dynamics 18, 1313–1325.CrossRefGoogle Scholar
Henzel, S. and Wieland, E. (2017) International synchronization and changes in long-term inflation uncertainty. Macroeconomic Dynamics 21, 918–946.CrossRefGoogle Scholar
Henzel, S. R. and Rengel, M. (2017) Dimensions of macroeconomic uncertainty: A common factor analysis. Economic Inquiry 55, 843–877.CrossRefGoogle Scholar
Jurado, K., Ludvigson, S. C. and Ng, S. (2015) Measuring uncertainty. American Economic Review 105, 1177–1216.CrossRefGoogle Scholar
Kim, S., Shephard, N. and Chib, S. (1998) Stochastic volatility: Likelihood inference and comparison with ARCH Models. The Review of Economic Studies 65, 361–393.CrossRefGoogle Scholar
Lewbel, A. (2012) Using heteroskedasticity to identify and estimate mismeasured and endogenous regressor models. Journal of Business and Economic Statistics 30, 67–80.CrossRefGoogle Scholar
Lin, S. (2010) On the international effects of inflation targeting. The Review of Economics and Statistics 92, 195–199.CrossRefGoogle Scholar
Lin, S. and Ye, H. (2007) Does inflation targeting really make a difference? Evaluating the treatment effect of inflation targeting in seven industrial countries. Journal of Monetary Economics 54, 2521–2533.CrossRefGoogle Scholar
Lin, S. and Ye, H. (2009) Does inflation targeting make a difference in developing countries? Journal of Development Economics 89, 118–123.CrossRefGoogle Scholar
Mertens, E. (2016) Measuring the level and uncertainty of trend inflation. Review of Economics and Statistics 98, 950–967.CrossRefGoogle Scholar
Mishkin, F. (2000) Inflation Targeting in Emerging Countries. NBER Working Paper No. 7618.CrossRefGoogle Scholar
Primiceri, G. E. (2005) Time varying structural vector autoregressions and monetary policy. Review of Economic Studies 72, 821–852.CrossRefGoogle Scholar
Roger, S. and Stone, M. (2005) On target? The international experience with achieving inflation targets. Technical Report. International Monetary Fund.Google Scholar
Ruge-Murcia, F. J. (2003) Inflation targeting under asymmetric preferences. Journal of Money, Credit and Banking 35, 763–785.CrossRefGoogle Scholar
Schaechter, A., Stone, M. R. and Zelmer, M. (2000) Adopting inflation targeting: Practical issues for emerging market countries. Technical Report. IMF Occasional Paper No. 202. Washington D.C.: International Monetary Fund.Google Scholar
Sims, C. A. and Zha, T. (2006) Does monetary policy generate recessions? Macroeconomic Dynamics 10, 231–272.CrossRefGoogle Scholar
Stock, J. and Watson, M. (2007) Why has US inflation become harder to forecast? Journal of Money, Credit and Banking 39, 3–33.CrossRefGoogle Scholar
Taylor, J. B. (2000) Low inflation, pass-through, and the pricing power of firms. European Economic Review 44, 1389–1408.CrossRefGoogle Scholar
Wright, J. (2011) Term premia and inflation uncertainty: Empirial evidence from an international panel data set. American Economic Review 101, 1514–1534.CrossRefGoogle Scholar