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Has the link between inflation uncertainty and interest rates changed after inflation targeting?

Has the link between inflation uncertainty and interest rates changed after inflation targeting? Purpose – The purpose of this paper is to establish a link between inflation uncertainty and interest rates for five inflation‐targeting countries. Design/methodology/approach – The approach takes the form of a time‐varying parameter model with a Generalized Autoregressive Conditional Heteroskedasticity (GARCH) specification, used to derive impulse uncertainty and structural uncertainty. Findings – This study attempts to establish a link between inflation uncertainty and interest rates for five inflation‐targeting countries, i.e. Canada, Finland, Spain, Sweden, and the UK. Decomposing inflation uncertainty into two components – impulse and structural, a positive association was found between the expected inflation and interest rates. Structural uncertainty has a positive and significant effect on interest rates for some countries. It has also been found that the long‐run effects of inflation on interest rates are less than unity for the post‐inflation targeting period, which implies that in some respect the Central Bank has been successful in targeting inflation. This has allowed the Central Bank to employ a less restrictive monetary policy in an environment of a credible inflation‐targeting strategy. Research limitations/implications – Exponential Generalized Autoregressive Conditional Heteroskedasticity (EGARCH) can be used instead of GARCH modelling. Originality/value – This is the first study that has tried to establish the link between different types of inflation uncertainty and interest rates for the inflation‐targeting countries to see the effect of inflation targeting. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Economic Studies Emerald Publishing

Has the link between inflation uncertainty and interest rates changed after inflation targeting?

Journal of Economic Studies , Volume 38 (6): 17 – Nov 1, 2011

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Publisher
Emerald Publishing
Copyright
Copyright © 2011 Emerald Group Publishing Limited. All rights reserved.
ISSN
0144-3585
DOI
10.1108/01443581111177358
Publisher site
See Article on Publisher Site

Abstract

Purpose – The purpose of this paper is to establish a link between inflation uncertainty and interest rates for five inflation‐targeting countries. Design/methodology/approach – The approach takes the form of a time‐varying parameter model with a Generalized Autoregressive Conditional Heteroskedasticity (GARCH) specification, used to derive impulse uncertainty and structural uncertainty. Findings – This study attempts to establish a link between inflation uncertainty and interest rates for five inflation‐targeting countries, i.e. Canada, Finland, Spain, Sweden, and the UK. Decomposing inflation uncertainty into two components – impulse and structural, a positive association was found between the expected inflation and interest rates. Structural uncertainty has a positive and significant effect on interest rates for some countries. It has also been found that the long‐run effects of inflation on interest rates are less than unity for the post‐inflation targeting period, which implies that in some respect the Central Bank has been successful in targeting inflation. This has allowed the Central Bank to employ a less restrictive monetary policy in an environment of a credible inflation‐targeting strategy. Research limitations/implications – Exponential Generalized Autoregressive Conditional Heteroskedasticity (EGARCH) can be used instead of GARCH modelling. Originality/value – This is the first study that has tried to establish the link between different types of inflation uncertainty and interest rates for the inflation‐targeting countries to see the effect of inflation targeting.

Journal

Journal of Economic StudiesEmerald Publishing

Published: Nov 1, 2011

Keywords: Kalman filter; Inflation uncertainty; Interest rates; Inflation

References