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Inflation uncertainty

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Abstract

We use a Markov regime switching structural GARCH-in-Mean VAR model for the inflation rate, the output gap, and a short-term nominal interest rate, to investigate the relationship between inflation uncertainty and economic activity in the USA. We find that inflation uncertainty has a negative and statistically significant effect on the output gap. Also, inflation shocks have a negative effect on the output gap, irrespective of whether they are positive or negative, with the asymmetry being caused by the negative effects of inflation uncertainty.

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Notes

  1. We also estimated the model allowing three regimes. However, the three-regime model is not statistically superior to the two-regime model.

  2. We provide the impulse response functions of the interest rate to inflation shocks in Appendix Fig. 3. The figure shows an increase (decrease) in inflation brings a persistent increase (decrease) in the interest rate. However, the magnitudes differ because of the inflation uncertainty parameter, and the decline in the interest rate is relatively large. This is because the presence of inflation uncertainty always hurts the output gap. Therefore, a negative inflation shock and uncertainty call for a more accommodating monetary policy.

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Authors and Affiliations

  1. Department of Economics, University of Calgary, Calgary, Canada

    Apostolos Serletis

  2. Department of Economics, Lakehead University, Thunder Bay, Canada

    Libo Xu

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  1. Apostolos Serletis
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  2. Libo Xu
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Correspondence to Apostolos Serletis.

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We would like to thank the Editor, Robert M. Kunst, and two anonymous referees for comments that greatly improved the paper.

Appendix

Appendix

See Fig. 3.

Fig. 3
figure 3

Generalized impulse responses. Note Each panel shows the median (solid black line) and the 16th and 84th percentiles (dashed red lines) of the impulse response of output gap to a one-standard deviation inflation shock. They are obtained by applying the Random Walk Metropolis method

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Serletis, A., Xu, L. Inflation uncertainty. Empir Econ 66, 1903–1920 (2024). https://doi.org/10.1007/s00181-023-02512-9

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