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INFLATION TARGETING UNDER INFLATION UNCERTAINTY—MULTI-ECONOMY EVIDENCE FROM A STOCHASTIC VOLATILITY MODEL

Published online by Cambridge University Press:  29 December 2020

Matthias Hartmann ,
Helmut Herwartz  and
Maren Ulm
Matthias Hartmann
Affiliation:
Center for European Studies, University of Milan
Helmut Herwartz
Affiliation:
Georg-August-University Göttingen
Maren Ulm*
Affiliation:
Georg-August-University Göttingen
*
Address correspondence to: Maren Ulm, Department of Economics, Georg-August-University Göttingen, Humboldtallee 3, 37073Göttingen, Germany. e-mail: mulm@uni-goettingen.de, maren.ulm@web.de.
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Abstract

One of the most important advantages of an inflation target is that it helps to reduce uncertainty about future inflation. However, this confidence may be undermined if actual inflation continuously deviates from the target level. We examine how inflation uncertainty relates to the presence of an inflation target and deviations of inflation from the targeted level. Inflation uncertainty is quantified by means of an unobserved components stochastic volatility model that allows to distinguish between permanent and transitory inflation uncertainty. While long-term inflation appears largely stable in most economies, the short-term inflation uncertainty is found to be time-varying. Most notably, short-term inflation uncertainty is high if inflation rates are below the target level. This is particularly relevant for economies which are currently confronted with the presence of persistently low-inflation rates. Our findings suggest that announcing higher inflation targets as it is currently discussed may be costly in terms of provoking higher inflation uncertainty.

Keywords

Inflation TargetingInflation UncertaintyStochastic VolatilityIdentification through Heteroscedasticity
Type
Articles
Information
Macroeconomic Dynamics , Volume 26 , Issue 5 , July 2022 , pp. 1302 - 1337
Copyright
© Cambridge University Press 2020

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Footnotes

We thank Geert Bekaert, Benjamin Born, Zeno Enders, Jan-Oliver Menz, Elmar Mertens and Henning Weber, the editor William A. Barnett, and two anonymous referees as well as conference participants at the SMYE 2017 Halle for helpful comments. Financial support from the Fritz-Thyssen Foundation is gratefully acknowledged.

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