The Relation between Inflation and Inflation Uncertainty in Iran's Economy: Nonparametric Regression Approach and BIP-GARCH

Document Type : Original Article

Authors

1 Ph.D. in Financial Engineering, Faculty of Economics, Management and Accounting, Yazd University, Yazd, Iran

2 PhD Candidate in Accounting, Faculty of Accounting & Financial Sciences, University of Tehran, Tehran, Iran

3 Associate Professor of Management, Faculty of Financial Sciences, Management and Entrepreneurship, Kashan University, Kashan, Iran

10.48308/jem.2024.232380.1848

Abstract

The relation between inflation and inflation uncertainty is one of the most important empirical relationships in macroeconomics. Some views suggest that the rise in inflation creates real costs through the impact on inflation uncertainty. Another view considers the increase in inflationary uncertainty as a priority to the increase in inflation. The causal direction of this relationship will determine the optimal strategy of central bank in the implementation of monetary policies. In this paper, first, using the MS model with three regimes, future inflation forecast errors are calculated, and then, using the BIP-GARCH method, the conditional variance of inflation is extracted as a proxy of inflation uncertainty. Finally, by using Granger causality test, various hypotheses on the relationship between inflation and inflation uncertainty are investigated, and with the nonparametric regression method, this relationship is inflationary in different intervals. The findings indicate that inflation uncertainty increases during periods of political turmoil and is strongly influenced by exchange rate fluctuations. The non-refinement of outlier forecast errors caused by large and temporary shocks will lead to the IGARCH(1,1) model, which means that the effect of shocks is unlimited for inflation uncertainty over time. Also, the non-parametric estimation between inflation and inflation uncertainty shows the dependence of this relationship in inflation intervals. In addition, the results show that inflation uncertainty affects future inflation in a non-linear way. As a result, the central bank can control the inflation rate by reducing the uncertainty of monetary policy through correcting inflationary expectations.

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References

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