Inflation and Inflation Volatility Revisited

Authors


  • The authors are grateful to R. Rigobon for kindly making available computer code, to the editor Benn Steil and two anonymous referees for helpful suggestions, and to Kuo-Hsuan Chin for his excellent research assistance. Financial support from the National Science Council in Taiwan under Contract NSC 97-2410-H-032-003 is herewith gratefully acknowledged. The usual disclaimer applies.

Dong-Hyeon Kim

Department of Food and Resource Economics

Korea University

145, Anam-ro, Seongbuk-gu

Seoul 136-701, Republic of Korea

dhyeonkim@yahoo.com.

Abstract

The link between inflation and its variability has been a topic of considerable interest and dispute, with theoretical disagreements and inconclusive empirical results. Empirical problems often arise from endogeneity and reverse causality. This paper reassesses the link through a system of simultaneous equations that addresses the reverse causality issue. Employing the identification through heteroskedasticity approach as an identification strategy and using a panel of 105 countries over the period 1960–2007, we find a two-way interaction between inflation and its variability. In particular, higher inflation increases inflation volatility, which is in line with the Friedman-Ball Hypothesis. Consistent with the Cukierman-Meltzer arguments, moreover, greater inflation volatility fuels inflation. The evidence is robust to alternative model specifications, time periods, and country characteristics.

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