Inflation and inflation uncertainty in the Euro area

Caporale, Guglielmo Maria, Onorante, Luca and Paesani, Paolo (2009) Inflation and inflation uncertainty in the Euro area. Centre for International Capital Markets discussion papers, 2009 (13). pp. 1-21. ISSN 1749-3412


This paper estimates a time-varying AR-GARCH model of inflation producing measures of inflation uncertainty for the euro area, and investigates the linkages between them in a VAR framework, also allowing for the possible impact of the policy regime change associated with the start of EMU in 1999. The main findings are as follows. Steady-state inflation and inflation uncertainty have declined steadily since the inception of EMU, whilst short-run uncertainty has increased, mainly owing to exogenous shocks. A sequential dummy procedure provides further evidence of a structural break coinciding with the introduction of the euro and resulting in lower long-run uncertainty. It also appears that the direction of causality has been reversed, and that in the euro period the Friedman-Ball link is empirically supported, implying that the ECB can achieve lower inflation uncertainty by lowering the inflation rate.

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