The relationship between the inflation rate and its variability: the issues reconsidered

This paper empirically reexamines the hypothesis of a positive relationship between the inflation rate and its variability. The sample consists of 66 countries for the 1955–85 sample period. Using pooled cross-section time series data, empirical tests are performed for nine different country-groupings ranging from the G–7 developed countries to a group of 10 developing Asian countries. Several important conclusions can be derived. First, irrespective of the variability measure employed, the results indicate the presence of a significant positive relationship between the inflation rate and its variability. This provides strong support to Okun's hypothesis. Second, this relationship is stronger during the flexible rather than the fixed exchange rate period. Third, there appears to be an optimum zone of inflation rate within which the predictability of inflation is at its highest and hence uncertainty cost is at its lowest. For the 1955–85 sample period, this optimum zone of average inflation rate lies in the range of 5 to 7 percent.