Narrow Results

This paper investigates the links between inflation, its uncertainty and economic growth in five ASEAN countries over the period 1980: Q1–2011: Q3. We rely on the Exponential GARCH (EGARCH) model to explore the causal relationship among the three variables. The major findings are: (i) inflation uncertainty increases more in response to positive inflation surprises than to negative surprises in all countries; (ii) inflationary shocks affect positively inflation uncertainty as predicted by the Friedman–Ball hypothesis; (iii) there is no evidence to suggest that inflation uncertainty causes inflation and; (iv) there is evidence that inflation affects growth negatively, both directly and indirectly (via the inflation uncertainty channel). The indirect effect is clearly stronger as it applies in all countries in the sample.

Recent research in macroeconomics has sought to develop a tractable form of heterogeneity in attempting to model sluggish responses in the price level. In addition, economists have struggled to explain why the demand for safe assets has increased as evidenced by the decline in real interest rates and even nominal interest rates in the last three decades [King, M (2017). Uncertainty and large swings in activity. In National Bureau of Economic Research Martin Feldstein Lecture, Cambridge, MA: NBER Summer Institute; King, M and D Low (2014). Measuring the ‘World’ Interest Rate. National Bureau of Economic Research Working Paper 19887, Cambridge, MA]. We build a simple two-period lived overlapping generations model that displays both heterogeneity of expectations and robustness. Our goal is to derive the economic impacts associated with greater uncertainty; more specifically, to answer the question can these two versions of uncertainty account for an increase in the demand for money and the low return on safe assets? Since analysis of even such a simple model requires a lot of technical work, we put most of this technical work into a rather lengthy technical Appendix for the benefit of readers who wish to follow such details. The main text in the paper will just focus on the basic economics.

This investigation tests the dynamic and quantile causality between inflation and inflation uncertainty of China with constructing a rolling-window based quantile causality test. The result shows unidirectional causality from inflation to inflation uncertainty, which is significantly asymmetric and time-varying. Inflation more likely causes inflation uncertainty in higher quantiles, indicating the linear model based on conditional mean may overestimate this impact in a lower quantile interval. Furthermore, the influence also exhibits a consistent time-varying property that cannot be explained simply by the conditional distribution. The causality shows more significance since 2007 when China cancelled the mandatory settlement system, which led to the increase of monetary policy independence. The time-varying nature indicates institutional changes may lead to regime switching of this causality. Our result supports the Friedman–Ball hypothesis [Friedman, M (1977). Nobel lecture: Inflation and unemployment. Journal of Political Economy, 85(3), 451–472; Ball, L (1992). Why does high inflation raise inflation uncertainty? Journal of Monetary Economic, 29(3), 371–388] to a certain extent and implies that the purpose of controlling inflation uncertainty of China can be achieved by controlling inflation if and only if it is relatively high on the premise of the independence of monetary policy.