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Inflation and Inflation Uncertainty The Case of Iran

Payman Ghorbani (Ph.D)

Economic Research and Policy Department

Central Bank of I.R.Iran

May 2012

A Review of Literature about Inflation and

Inflation Uncertainty• Effects and Costs of Uncertainty about

Future Inflations

• Previous Empirical Researches

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• variability of inflation as a proxy for inflation uncertainty

• Survey Strategy

• Econometric Approach

-Okun (1971), Taylor (1981) and Ball and Cecchetti (1990) - (+)

-Katsimbris (1985) – (no significant relationship)

Wachtel (1997), Carlson (1977), and Cukierman and Wachtel (1979)) – (+)

Engle (1983), Cosimano and Jansen (1988), and Baillie, Chung, and Tieslau (1992)-(no significant relationship)

Bruner and Hess (1993), Tevfik and Perry (2000), Kontonikas (2002) , and Thornton (2007) – (+)

Tashkini (2005) , Dahmardeh, Pourshahabi and Khani Zade Amiri (2010), and Farzinvash, Mehrara and Abbasi (2005) - (+)

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Does an increase in the rate of inflation cause an increase in inflation uncertainty?

If it does, so it can be concluded that greater uncertainty is part of costs of inflation.

Meantime, the causality between inflation and inflation uncertainty plays an important role in the specification of econometric models.

Econometric Models of InflationUncertainty

t t ty X

2 2

1

0, 0, 1,...,

p

t o i t ii

o i i p

t t ty X

4

GARCH (p,q)

t t ty X

2 2 2

1 1

0, 0, 0 1,..., , 1,...,

p q

t i t i j t ji j

i j i p j q

The GARCH in Mean (GARCH-M) Model

The Threshold-GARCH (TGARCH) Model

Regressors in the Variance Equation

2t t t ty X

2 2 2

1 1

p q

t i t i j t j ti j

z

5

Distributional Assumptions2

2

2

( )1 1 1log(2 ) log

2 2 2

t t

t t

t

y Xl

22

2

2 2

( )1 ( 2) ( / 2) 1 ( 1)log log log 1

2 (( 1) / 2) 2 2 ( 2)

t t

t t

t

y Xl

/223

2

2 2

(3/ )( )1 (1/ ) 1log log

2 (3/ )( / 2) 2 (1/ )

r

t t

t t

t

r y Xrl

r r r

An overview of Iranian Inflation Data

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ADF Test

1

11

95p

t t i t i t ti

t DUM

Model Specification

1 1 ...t t m t m t

2 2 2

1 1

p q

t i t i j t ji j

7

Our Model

4

0 11

95t t m t m tm

DUM

2 2 21 1t t t

8

GED parameter (H0: r=2)

ARCH LM Test:

2 20

1

d

t s t s ts

e e

0 1 2: ... 0dH

Granger Causality Test

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M-GARCH-M

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GED parameter (H0: r=2)

ARCH LM Test:

Threshold GARCH

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GED parameter (H0: r=2)

ARCH LM Test:

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Leverage Effect

News Impact Curve (NIC)

0 : 0H

Granger Causality Test

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M-TGARCH-M

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GED parameter (H0: r=2)

ARCH LM Test:

Leverage Effect

News Impact Curve (NIC)

0 : 0H

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The leverage effect is present. In fact, the future inflation uncertainty is sensitive to “bad” news (unexpected increase in inflation) while it appears almost unaffected when there is “good” news (unexpected decrease in inflation).

Inflation has a positive effect on inflation uncertainty which confirms Milton Friedman’s hypothesis expressed in his Nobel lecture (1977). However, the effect of inflation uncertainty on inflation is negative and insignificant. This negative sign supports Holland’s finding (1995) who

explains this by the stabilisation motive of policy makers.

the conditional error distribution is fat-tailed

foreign debt crisis in 1995 has increased the inflation rate in the Iranian economy

Overall, the results of this study show that increase in the rate of inflation will raise the inflation uncertainty and suggest that higher inflation uncertainty is part of the welfare cost of inflation in the Iranian economy.