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Asymmetric Causality Between Inflation and Uncertainty: Evidences from 33 Developed and Developing Countries

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Abstract

Empirical studies have provided conflicting findings about the relationship between inflation and inflation uncertainty. Thus, the direction of the causality is still questionable. The present paper is aimed to extend the existing literature using non-linearity models and asymmetric causality tests. For this purpose, the data for 33 developed and developing countries during 1988Q4-2016Q3 is used. The results showed an asymmetry in the inflation behavior which is specified by smooth transition process, as well as separating positive and negative shocks observed in causality test. The asymmetric causality between inflation and inflation uncertainty is confirmed in most countries, although the empirical evidence in favor of Cukierman-Meltzer hypothesis is found to be weaker than Friedman-Ball hypothesis.

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Notes

  1. First, when inflation is more unpredictable, investors will require higher expected returns, subsequently interest rates will be expected to be higher. Therefore, businesses and consumers will invest less in equipment and durable goods, respectively. Second, one occurs when the uncertainty is transmitted to other economic variables influencing economic decisions of consumers and businesses. For example, uncertainty about interest rates, wages, tax rates, and profits may induce businesses to delay investment and production decisions. Third, one occurs when businesses spend resources to improve their forecast of inflation, and also try to hedge against unexpected inflation using derivative instruments. Thus resources are diverted from other more productive activates.

  2. Thus, Friedman’s theory includes two hypotheses, which only the first one is studied in the present paper.

  3. Process persistence is calculated by mean or median lag in an autoregressive model (see Fischer et al. (2002), and Falahi and Hajamini (2017), for more detail).

  4. Toda and Phillips (1993a) argue that Granger causality test may not be reliable for non-stationary variables. Furthermore, regarding Johnson-type ECM model as alternative approach, some such as Rahbek and Mosconi (1999), Toda and Yamamoto (1995), Toda and Phillips (1993b), and Reimers (1992) indicated that the robustness of the hypothesis tests significantly decreases if the variables are not integrated in order one.

  5. Quarterly adjusted data were used in this study, as the inflation rate displays some forms of seasonal variation.

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  1. Department of Economics, Yazd University, Yazd, Iran

    Mehdi Hajamini

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Hajamini, M. Asymmetric Causality Between Inflation and Uncertainty: Evidences from 33 Developed and Developing Countries. J. Quant. Econ. 17, 287–309 (2019). https://doi.org/10.1007/s40953-019-00165-z

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