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Inflation, Inflation Uncertainty and a Common European Monetary Policy

Stilianos Fountas (), A. Ioannidis and Menelaos Karanasos ()

Manchester School, 2004, vol. 72, issue 2, 221-242

Abstract: The relationship between inflation and inflation uncertainty is investigated in six European Union countries for the period 1960–99. Exponential generalized autoregressive conditional heteroscedasticity models are used to generate a measure of inflation uncertainty and then Granger methods are employed to test for causality between average inflation and inflation uncertainty. In all the European countries except Germany, inflation significantly raises inflation uncertainty as predicted by Friedman. However, in all countries except the UK, inflation uncertainty does not cause negative output effects, implying that a common European monetary policy applied by the European Central Bank might lead to asymmetric real effects via the inflation uncertainty channel. Less robust evidence is found regarding the direction of the impact of a change in inflation uncertainty on inflation. In Germany and the Netherlands, increased inflation uncertainty lowers inflation, while in Italy, Spain and, to a lesser extent, France increased inflation uncertainty raises inflation. These results are generally consistent with the existing rankings of central bank independence.

Date: 2004
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