Inflation, inflation uncertainty and Markov regime switching heteroskedasticity: evidence from European countries
Keywords:Inflation, Inflation uncertainty, Markov process, regime-switching heteroskedasticity
AbstractWe use a Markov regime-switching heteroskedasticity model in order to examine the association between inflation and inflation uncertainty in four European countries over a forty-year period. This approach allows for regime shifts in both the mean and variance of inflation in order to assess the association between inflation and its uncertainty in short and long horizons. We find that this association differs (i) between transitory and permanent shocks to inflation and (ii) across countries. In particular, the association is positive or zero for transitory shocks and negative or zero for permanent shocks. Hence, Friedman’s belief that inflation is positively associated with inflation uncertainty is only partially supported in this study, i.e., with short-run inflation uncertainty.