Is the Relationship between Inflation and Its Uncertainty Linear?

Menelaos Karanasos 1  und Stefanie Schurer 2
  • 1 Brunel University, Kingston Ln, London,, Uxbridge, United Kingdom of Great Britain and Northern Ireland
  • 2 Ruhr Graduate School in Economics, Bochum,, North Rhine-Westphalia, Germany

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 heteroscedasticity parameter influences this relationship significantly.

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German Economic Review (GER), the official publication of the German Economic Association (Verein für Socialpolitik), is an international journal publishing original and rigorous research of general interest in a broad range of economic disciplines. The scope of research approaches includes theoretical, empirical and experimental work.

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