The relationship between inflation, output growth, and inflation uncertainty: Panel data evidence from selected industrial countries

Abstract

In this chapter, we have examined the causal relationships among the inflation rate, output growth rate, and inflation uncertainty for a panel of industrialized countries. For this purpose, we have estimated a PANEL-GARCH model for inflation rate and performed Panel-causality tests using conditional standard deviations of inflation to proxy nominal uncertainty. The relationships among inflation, output growth, and inflation uncertainty have been investigated extensively in the empirical literature for developed countries (e.g., Grier and Perry 1998; Davis and Kanago, 2000; Fountas et al. 2006; Fountas and Karanasos 2007). Our main contribution is to extend the analysis conducted by these studies to a group of developed countries using panel data techniques. The panel Granger test results have showed that the Friedman-Ball hypothesis is not supported by data when applied to the group of countries included in this chapter. This has led us to conclude that a threshold level of inflation does exist before the Friedman- Ball hypothesis applies. On the other hand, the reported test results have provided empirical support for the Cukierman-Meltzer (1986) hypothesis that inflation uncertainty raises the inflation rate in the group of industrialized countries under investigation. Our findings regarding the causal relationship between inflation uncertainty and output growth report a bidirectional relationship between these two variables. While output growth leads to an increase in inflation uncertainty at first lag, this effect is found to be insignificant at fourth lags. However, inflation uncertainty is found to be detrimental for real growth uniformly across the lags considered. Finally, a negative bidirectional causal relation was detected between output growth and inflation.