Testing the relationship between Inflation, Inflation uncertainty and Output Growth:Evidence from the G-20 Countries.

Abstract

This study examines the relationship between inflation, inflation uncertainty and output growth for the G-20 countries using several GARCH and GARCH-M models in order to generate a measure of inflation uncertainty. The test for the impact of inflation uncertainty on inflation and vice versa is adopted in two approaches. The first approach is based on the GARCH-M model that allows for simultaneous feedback between the conditional mean and variance of inflation and the second on a two-step procedure where Granger methods are employed using the conditional variance of a simple GARCH model. The results suggest significant positive relationship between inflation and inflation uncertainty in most countries, supporting the Cukierman-Meltzer and Friedman-Ball hypotheses. There is also some evidence for the Holland theory, that uncertainty lead to lower inflation. In addition, the examination of the effect of inflation uncertainty on output growth is approached with the two-step procedure, where the evidence that inflation uncertainty has negative real effects receives very little support.