Abstract
Since the 1990s, central banks in many industrialized and developing countries have adopted similar policy strategies for stabilizing inflation. In this context, it has been argued that during common policy periods, the relationships between inflation, output growth, and their uncertainties are stable and more uniform across countries. We intend to verify this for 19 countries using both linear and non-linear bivariate GARCH-in-mean models. According to our findings, the non-linear regime-dependent model performs better in most of the sampled countries. It has been observed that inflation uncertainty has a significant impact on inflation, particularly in developing countries. Nominal and real uncertainty affect output growth primarily during periods of economic contraction. Although nominal uncertainty inhibits output growth, real uncertainty has mixed effects. In most countries, negative growth shocks result in greater output growth volatility than positive growth shocks. Furthermore, in some countries, output growth significantly increases inflation only in high-inflation regimes.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
Several competing theories have been proposed in the last three decades in order to explain the above linkages. Simultaneously, a substantial amount of empirical research has been carried out to determine the true nature of these relationships [see Fountas et al. (2006), Bredin and Fountas (2009), Bhar and Mallik (2013), and Conrad and Karanasos (2015) for details on the theories and empirical works]. The empirical results, however, are not conclusive; rather, they vary significantly across countries depending on monetary policy regimes and economic development of a country.
In the ‘two-step’ procedure (Fountas et al. 2002; Fountas and Karanasos 2007), a bivariate GARCH type model has been employed in the first step to estimate the conditional volatilities of inflation and output growth, and then in the second step, a VAR setup with inflation, growth, and their respective volatilities has been used to examine different possible causal relationships.
Except Neanidis and Savva (2013), who consider data from G7 countries, other studies mainly focus on the USA.
In the literature, the diagonal CCC (constant conditional correlation) of Bollerslev (1990) and the BEKK model of Engle and Kroner (1995) are frequently used to measure macroeconomic uncertainties in a bivariate framework (Grier et al. 2004; Bredin and Fountas 2005, 2009; Shields et al. 2005; Fountas et al. 2006; Bhar and Mallik 2010; Conrad and Karanasos 2010).
SETVAR-AGARCH-M nests both VAR-GARCH-M and VAR-AGARCH-M, whereas VAR-GARCH-M is nested in VAR-AGARCH-M.
By expanding Eq. (3), we obtain the following specification for the conditional variance of inflation \({h}_{x, t}={c}_{11}^{2}+{c}_{12}^{2}+{\alpha }_{11}^{2}{\varepsilon }_{x,t-1}^{2}+2{\alpha }_{11}{\alpha }_{12}{\varepsilon }_{x, t-1}{\varepsilon }_{y, t-1}+{\alpha }_{12}^{2}{\varepsilon }_{y,t-1}^{2}+{\beta }_{11}^{2}{h}_{x, t-1}+2{\beta }_{11}{\beta }_{12}{h}_{xy, t-1}+{\beta }_{12}^{2}{h}_{y, t-1}+{d}_{11}^{2}{u}_{x,t-1}^{2}+2{d}_{11}{d}_{12}{u}_{x, t-1}{u}_{y, t-1}+{d}_{12}^{2}{u}_{y,t-1}^{2}\).
The conditional variance of output growth can be specified in a similar way. It is worth noting that the direct effect of real uncertainty on nominal uncertainty (indicated by \({\alpha }_{12}^{2}\), \({\beta }_{12}^{2}\), and \({d}_{12}^{2}\)) is positive. The coefficient \({d}_{11}^{2}\) also indicate that the asymmetric effect of negative shocks in inflation on inflation uncertainty is positive.
Among this group, some countries like Brazil, the Philippines, Norway, Spain, Sweden, the UK, the USA, Chile, Israel, and South Africa are inflation targeters, and the rest are non-inflation targeters. Although non-targeting countries lack an explicit inflation target, they frequently announce a desired level of inflation and periodically evaluate monetary policies in pursuit of price stability. For instance, the European Central Bank (ECB) does not consider itself an inflation targeting-central bank; however, since the inception of the euro in 1999, it has set a desired inflation rate of 2% or less for all euro area countries.
According to data availability, the beginning and ending dates for the Philippines, Barbados, Chile, and Jordan are January 1993 and December 2017, January 1990 and October 2014, January 1997 and December 2017, and January 1997 and December 2017, respectively. In Brazil, we have chosen January 1995 as the starting point, thus excluding the hyperinflationary periods of the first half of the 1990s.
In order to reduce the computational burden, the search for an optimal p was limited to lags from 1 to 8 for all countries. The results are available on request.
We have performed the Ljung-Box test on both standardized and squared standardized residuals to examine the adequacy of our models. However, we do not report them for brevity, but they are available on request.
References
Ball LM, Sheridan N (2004) Does inflation targeting matter? In: The inflation-targeting debate. University of Chicago Press, pp 249–282
Benalal N, Diaz del Hoyo JL, Pierluigi B, Vidalis N (2006) Output growth differentials across the euro area countries: some stylised facts. ECB occasional paper no. 45
Bernanke BS (1983) Nonmonetary effects of the financial crisis in the propagation of the great depression. Am Econ Rev 73(3):257–276
Bernanke BS (2004) The great moderation, vol 20. The Federal Reserve Board, Washington
Bhar R, Mallik G (2010) Inflation, inflation uncertainty and output growth in the USA. Physica A 389(23):5503–5510
Bhar R, Mallik G (2013) Inflation uncertainty, growth uncertainty, oil prices, and output growth in the UK. Empir Econ 45(3):1333–1350
Black F (1987) Business cycles and equilibrium. Basil Blackwell, New York
Bloom N (2009) The impact of uncertainty shocks. Econometrica 77(3):623–685
Bollerslev T (1986) Generalized autoregressive conditional heteroskedasticity. J Econometr 31(3):307–327
Bollerslev T (1990) Modelling the coherence in short-run nominal exchange rates: a multivariate generalized ARCH model. Rev Econ Stat 72(3):498–505
Bollerslev T, Wooldridge JM (1992) Quasi-maximum likelihood estimation and inference in dynamic models with time-varying covariances. Economet Rev 11(2):143–172
Bredin D, Fountas S (2005) Macroeconomic uncertainty and macroeconomic performance: Are they related? Manch Sch 73(s1):58–76
Bredin D, Fountas S (2009) Macroeconomic uncertainty and performance in the European Union. J Int Money Financ 28(6):972–986
Bruno M, Easterly W (1998) Inflation crises and long-run growth. J Monet Econ 41(1):3–26
Burdekin RC, Denzau AT, Keil MW, Sitthiyot T, Willett TD (2004) When does inflation hurt economic growth? Different nonlinearities for different economies. J Macroecon 26(3):519–532
Caggiano G, Castelnuovo E, Figueres JM (2020) Economic policy uncertainty spillovers in booms and busts. Oxford Bull Econ Stat 82(1):125–155
Caglayan M, Kocaaslan OK, Mouratidis K (2015) Regime dependent effects of inflation uncertainty on real growth: a Markov regime switching approach. Scott J Polit Econ. https://doi.org/10.1111/sjpe.12087
Caporale GM, Kontonikas A (2009) The Euro and inflation uncertainty in the European Monetary Union. J Int Money Financ 28(6):954–971
Cecchetti SG, Krause S (2001) Financial structure, macroeconomic stability and monetary policy. Working paper 8354, NBER
Chang KL (2012) The impacts of regime-switching structures and fat-tailed characteristics on the relationship between inflation and inflation uncertainty. J Macroecon 34(2):523–536
Chang K-L, He C-W (2010) Does the magnitude of the effect of inflation uncertainty on output growth depend on the level of inflation? Manchester School 78(2):126–148
Chowdhury KB, Kundu S, Sarkar N (2018) Regime dependent effects of uncertainty on inflation and output growth: evidence from the United Kingdom and the United States. Scott J Polit Econ 65(4):390–413
Conrad C, Karanasos M (2010) Negative volatility spillovers in the unrestricted ECCC-GARCH model. Economet Theor 26(3):838–862
Conrad C, Karanasos M (2015) Modeling the link between US inflation and output: the importance of the uncertainty channel. Scott J Polit Econ 62(5):431–453
Cukierman A, Meltzer AH (1986) A theory of ambiguity, credibility, and inflation under discretion and asymmetric information. Econometrica 54(5):1099–1128
De Haan J (2010) Inflation Differentials in the Euro Area: A Survey. In: De Haan J, Berger H (eds) The European Central Bank at Ten. Springer, Heidelberg, pp 11–32
Dotsey M, Sarte PD (2000) Inflation uncertainty and growth in a cash-in-advance economy. J Monet Econ 45(3):631–655
Dueker MJ, Fischer AM (2006) Do inflation targeters outperform non-targeters? Rev-Fed Reserv Bank Saint Louis 88(5):431
Easterly W, Islam R, Stiglitz J (2000) Explaining growth volatility. In: Annual World Bank conference on development economics (no. 28159).
Engle RF, Kroner KF (1995) Multivariate simultaneous generalized ARCH. Economet Theor 11(01):122–150
Ferreira D, Palma A (2016) Inflation and inflation uncertainty in Latin America: a time-varying stochastic volatility in mean approach. J Econ Stud 44(4):506–517
Fischer S (1993) The role of macroeconomic factors in growth. J Monet Econ 32(3):485–512
Fountas S, Karanasos M (2007) Inflation, output growth, and nominal and real uncertainty: empirical evidence for the G7. J Int Money Financ 26(2):229–250
Fountas S, Ioannidis A, Karanasos M (2004) Inflation, inflation uncertainty and a common European monetary policy. Manch Sch 72(2):221–242
Fountas S, Karanasos M, Kim J (2006) Inflation uncertainty, output growth uncertainty and macroeconomic performance. Oxford Bull Econ Stat 68(3):319–343
Franses PH, Van Dijk D (2000) Non-linear time series models in empirical finance. Cambridge University Press
Friedman M (1977) Nobel lecture: inflation and unemployment. J Polit Econ 85(3):451–472
García-Herrero A, Vilarrubia J (2007) The Laffer curve of macroeconomic volatility and growth: Can it be explained by the different nature of crises? Money Aff XX(1):43–60
Ghosh A, Phillips S (1998) Warning: inflation may be harmful to your growth. Staff Pap 45(4):672–710
Gillman M, Kejak M (2005) Contrasting models of the effect of inflation on growth. J Econ Surv 19(1):113–136
Gomme P (1993) Money and growth revisited: Measuring the costs of inflation in an endogenous growth model. J Monet Econ 32(1):51–77
Greenspan A (2004) Risk and uncertainty in monetary policy. Am Econ Rev 94(2):33–40
Grier KB, Perry MJ (2000) The effects of real and nominal uncertainty on inflation and output growth: some GARCH-M evidence. J Appl Economet 15(1):45–58
Grier KB, Henry ÓT, Olekalns N, Shields K (2004) The asymmetric effects of uncertainty on inflation and output growth. J Appl Economet 19(5):551–565
Hartmann M, Roestel J (2013) Inflation, output and uncertainty in the era of inflation targeting—a multi-economy view on causal linkages. J Int Money Financ 37:98–112
Henry OT, Olekalns N (2002) The effect of recessions on the relationship between output variability and growth. South Econ J 68(3):683–692
Holland AS (1995) Inflation and uncertainty: tests for temporal ordering. J Money, Credit Bank 37(3):827–837
Jiranyakul K, Opiela TP (2010) Inflation and inflation uncertainty in the ASEAN-5 economies. J Asian Econ 21(2):105–112
Jones LE, Manuelli RE (1995) Growth and the effects of inflation. J Econ Dyn Control 19(8):1405–1428
Khan MS, Senhadji AS (2001) Threshold effects in the relationship between inflation and growth. IMF Staff Pap 48(1):1–21
Kontonikas A (2004) Inflation and inflation uncertainty in the United Kingdom, evidence from GARCH modelling. Econ Model 21(3):525–543
Li J (2006) Testing Granger Causality in the presence of threshold effects. Int J Forecast 22(4):771–780
Lin S, Ye H (2007) Does inflation targeting really make a difference? Evaluating the treatment effect of inflation targeting in seven industrial countries. J Monet Econ 54(8):2521–2533
Mishkin FS, Schmidt-Hebbel K (2001) One decade of inflation targeting in the world: what do we know and what do we need to know? NBER working paper 8397
Neanidis KC, Savva CS (2013) Macroeconomic uncertainty, inflation and growth: regime-dependent effects in the G7. J Macroecon 35(1):81–92
Ollivaud P, Guillemette Y, Turner D (2016) Links between weak investment and the slowdown in productivity and potential output growth across the OECD. OECD Economics Department Working Papers
Pindyck RS (1991) Irreversibility, uncertainty, and investment. J Econ Lit 29(3):1110–1148
Schumpeter JA (1939) Business cycle: a theoretical, historical, and statistical analysis of the capitalist process. McGraw-Hill, New York
Shields K, Olekalns N, Henry ÓT, Brooks C (2005) Measuring the response of macroeconomic uncertainty to shocks. Rev Econ Stat 87(2):362–370
Stock JH, Watson MW (2003) Has the business cycle changed and why? NBER macroeconomics annual 2002. MIT Press 17:159–230
Stockman AC (1981) Anticipated inflation and the capital stock in a cash in-advance economy. J Monet Econ 8(3):387–393
Ungar M, Zilberfarb BZ (1993) Inflation and its unpredictability-theory and empirical evidence. J Money, Credit Bank 25(4):709–720
Walsh CE (2009) Inflation targeting: What have we learned? Int Finance 12(2):195–233
Acknowledgements
The author is grateful to the anonymous reviewers for their insightful comments on this paper. The valuable comments made by them have significantly improved the paper. The remaining errors, if any, are, however, the sole responsibility of the author.
Author information
Authors and Affiliations
Corresponding author
Ethics declarations
Conflict of interest
The author has no relevant financial or nonfinancial interests to disclose.
Additional information
Publisher's Note
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
Rights and permissions
Springer Nature or its licensor (e.g. a society or other partner) holds exclusive rights to this article under a publishing agreement with the author(s) or other rightsholder(s); author self-archiving of the accepted manuscript version of this article is solely governed by the terms of such publishing agreement and applicable law.
About this article
Cite this article
Chowdhury, K.B. Relationships between inflation, output growth, and uncertainty in the era of inflation stabilization: a multicountry study. Empir Econ 66, 623–650 (2024). https://doi.org/10.1007/s00181-023-02473-z
Received:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s00181-023-02473-z