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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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