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How does inflation determine inflation uncertainty? A Chinese perspective

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Abstract

Using a bootstrap Granger full-sample causality test and a sub-sample rolling window estimation, this paper examines the causal link between inflation and inflation uncertainty in China. The results show that high inflation leads to high inflation uncertainty, supporting Friedman-Ball’s hypothesis (1992) and Holland’s theory (J Money Credit Bank 27:827–837, 1995). Furthermore, significant feedback exists from inflation uncertainty to inflation in some periods, supporting Holland’s theory (J Money Credit Bank 27:827–837, 1995) that inflation uncertainty has a negative effect on inflation. We find that the relationship between inflation and inflation uncertainty varies across time. The Chinese monetary authority needs to ensure a quick and effective policy response to inflation development because doing so will help reduce inflation, eliminate many of the costs associated with high inflation and therefore minimize the marginal effect of inflation on inflation uncertainty. However, quantitative tools for China’s monetary policy are also warranted. In the long term, the importance of keeping inflation low, stable, and predictable cannot be overemphasized.

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Notes

  1. Specifically, the critical values and p values are obtained using asymptotic distribution constructed by means of Monte Carlo simulations using 2000 samples generated from a VAR model with constant parameters.

  2. We also estimated the coefficients of the Component GARCH model, AIC and BIC show it worse than E-GARCH and GJR-GARCH. To make the comparison directly, Table 1 doesn’t show the result of Component GARCH model.

  3. Though an interpretation for the selection of 24-month window size was provided earlier, we implemented different bootstrap rolling-window causality tests using 20-, 30-, 36-month window sizes. Furthermore, we estimated the magnitude of the effect of inflation on inflation uncertainty and that of inflation uncertainty on inflation. The results are similar to those from the causality test based on a 24-month window size, which further indicates that the results based on a 24-month window size are robust. The details of these results are available upon request from the authors.

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Acknowledgments

This research is supported by the National Social Science Foundation (Grant number: 15BJY155), and Ministry of Education’s Humanities and Social Science Research Project (Grant number: 14YJA790049).

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Authors and Affiliations

  1. Department of Finance, Ocean University of China, 238, Songling Rd., Qingdao, Shandong, China

    Chi-Wei Su, Hui Yu & Xiao-Lin Li

  2. Department of Accounting and Information, Ling Tung University, Taichung, Taiwan

    Hsu-Ling Chang

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  1. Chi-Wei Su
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Su, CW., Yu, H., Chang, HL. et al. How does inflation determine inflation uncertainty? A Chinese perspective. Qual Quant 51, 1417–1434 (2017). https://doi.org/10.1007/s11135-016-0341-2

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