The effects of inflation uncertainty on interest rates: a nonlinear approach

In this article, we investigate the effects of inflation variability on short-term interest rates within a nonlinear smooth transition regression framework. The test results suggest that only the conditional mean of the inflation is a nonlinear process whereas the conditional variance is time variant but linear. Using the square root of conditional variance as a proxy for inflation risk, we estimate Fisher equation augmented with inflation risk. Although the estimated Fisher equations suggest that inflation risk reduces short-term interest rates, we find that the effects of inflation risk on interest rates are regime-dependent. Particularly, we find that the negative effects of inflation variability on nominal rates are greater in low-inflationary regimes when compared to high-inflationary regimes. On the other hand, it is found that both inflation and inflation uncertainty raise the expected inflation effect.     

On the real effects of inflation and inflation uncertainty in Mexico

We estimate an augmented multivariate GARCH-M model of inflation and output growth for Mexico at business cycle frequencies. The main findings are: (1) inflation uncertainty has a negative and significant effect on growth; (2) once the effect of inflation uncertainty is accounted for, lagged inflation does not have a direct negative effect on output growth; (3) However as predicted by Friedman and Ball, higher average inflation raises inflation uncertainty, and the overall net effect of average inflation on output growth in Mexico is negative. That is, average inflation is harmful to Mexican growth due to its impact on inflation uncertainty. (4) The Mexican Presidential election cycle significantly raises inflation uncertainty both during the year of the election and the year following the election which has correspondingly negative effects on output growth.     

Keynes, uncertainty and interest rates

Uncertainty plays an important role in The General Theory, particularlyin the theory of interest rates. Keynes did not provide a theoryof uncertainty, but he did make some enlightening remarks aboutthe direction he thought such a theory should take. I arguethat some modern innovations in the theory of probability allowus to build a theory which captures these Keynesian insights.If this is the right theory, however, uncertainty cannot carryits weight in Keynes's arguments. This does not mean that theconclusions of these arguments are necessarily mistaken; intheir best formulation they may succeed with merely an appealto risk.     

Budget deficits,short-term real interest rates and the specification of expected inflation: an empirical investigation

The purpose of this paper is to illustrate whether empirical estimates of the effects of budget deficits on short-term real interest rates are sensitive to the choice of the expected inflation variable. Survey data on expected inflation and the rational expectations method described by Mishkin (1981) are used to construct two measures of the short-term real interest rate. Results for two previous studies on this deficit-interest rate relationship are re-estimated using these measures of expected inflation and the interest rate variables. Additional results reported in this paper further indicate that empirical estimates of the interest rate effects of budget deficits are sensitive to the choice of the expected inflation variable. In addition to the choice of the inflation variable, a number of other robustness tests are included. We are able to conclude that (1) increases in budget deficits do not generally raise short-term real interest rates and (2) short-term real interest rates are not independent of the expected inflation variable.

The rate of interest is always based upon expectation, however little this may be justified by realization. Man makes his guess of the future and stakes his action upon it … Our present acts must be controlled by the future, not as it actually is, but as it appears to us through the veil of chance (Fisher, 1907, p. 213).     

Mean-reversion in international real interest rates

This paper examines the mean-reversion property of real interest rates. Many past studies have reported puzzling outcomes of the mean-aversion of real interest rates for a number of countries. In the article, we employ panel unit root tests and carry out half-life estimation based on the bias-corrected bootstrap. These findings of the paper provide strong evidence that, in both major Western and East Asian capital markets (including several emerging ones), real interest rates are mean-reverting. In addition, we find evidence that the degree of mean-reversion of the real interest rates is positively correlated with that of output growth, which is consistent with the implications of standard intertemporal behavior.     

On the constancy of real interest rates

In the context of a small structural model, we show that the autocorrelation and the variance of the ex ante real rate of interest can be uniquely estimated; the random forecasting errors need not confound the problem of identifying variations in the real rate.     

The effects of the monetary policy regime shift to inflation targeting on the real interest rate in the United Kingdom

This paper studies the effects of the monetary policy regime shift to inflation targeting on the stochastic properties of the real interest rate in the U.K. The empirical analysis suggests a constant mean of the real interest rate that shifts with the monetary policy regime change to inflation targeting in October 1992. The mean-reverting level of the real interest rate has decreased from 5.1% to 2.3% per annum with the change in monetary policy to inflation targeting. In addition, the shift in monetary policy regime to inflation targeting has reduced the volatility of the real interest rate and increased the persistence of real interest rate deviations from the mean. The results suggest that the central bank can affect the stochastic properties of the real interest rate through the choice of monetary policy regime over a long period of time.     

The time-varying effect of inflation uncertainty on inflation for Turkey

We investigate the effect of inflation uncertainty on inflation from January 1982 through March 2016 for Turkey by using the Stochastic Volatility in Mean model with time-varying parameters. Our empirical evidence from consumer price index (CPI) inflation suggests that the observed positive relationship between inflation and inflation uncertainty is not robust. This positive relationship diminishes after 2002. This finding is valid for all five subcomponents of CPI inflation; however, for Health Services, Transportation Services, and Recreational and Cultural Services, an inflation-positive association is reported after 2010.     

Risk-aversion and the term structure of real interest rates

The term structure of real interest rates is studied in the context of a consumption-based general-equilibrium model. It is shown that the expectations hypothesis is approximately satisfied for low interest rate volatility. Otherwise the term premia are generally positive.     

The behaviour of expected short-term real interest rates in the UK

The existence of persistent technical inefficiency offers the opportunity for a ‘free lunch’ not typically implied by the neoclassical theory of the firm. When external effects are related to the use of particular inputs, reduction of persistent technically inefficient levels of input use represents a means of reducing external impacts. An important example is found in agriculture where substantial environmental impacts are generated by particular inputs. Within this context, this paper considers the usefulness of data envelopment analysis (DEA) for estimation of potential input reductions and assessment of potential reductions of environmental impacts of agricultural inputs. An application for French cereal production provides estimates that indicate that substantial potential exists for reduction of input use and environmental impacts.     

Real and nominal UK interest rates,ERM membership,and inflation targeting

This article estimates a two-factor term structure model to analyze the time-varying mean-reverting levels of the UK real and nominal short-term interest rates. Before and during British membership in the ERM, the mean-reverting levels of real and nominal short rates have a strong negative correlation. Afterward, when the UK implemented an inflation targeting policy, the mean-reverting levels have a strong positive correlation. The article also reports empirical evidence of a link between the time-varying central tendencies and inflation in the disinflation period before the implementation of the inflation targeting policy.     

Real wages,real interest rates,and the Phillips curve

This article argues that any analysis of a Phillips curve should include the real interest rate in addition to inflation and real wages as any changes in the interest rate changes the labour–capital input mix in the production process leading to a change in the level of employment in the economy. To justify this argument a Phillips curve model is developed, which includes the real interest rate in addition to inflation and real wages. After the diagnosis of the time series properties of the data, an error correction model is developed and estimated using a set of US annual data from 1948 to 1996. The estimated parameters of the model do suggest that one should really take into consideration of the real interest rate while analysing the Phillips curve. A non-nested test (F-test) also suggests that the Phillips curve model with real interest rate as an additional variable performs better than the conventional method that does not include the real interest rate.     

World real interest rates: a global savings and investment perspective

Over the past 15 years, long-term interest rates have declined to levels not seen since the 1970s. This article explores possible shifts in global savings and investment that have led to this fall in the world real interest rate. There are several key findings. First, the authors identify the relative weakness in investment demand as more important than the relative increase in desired global savings to explain the decline in global interest rates. Second, the results indicate that the key factors explaining movements in savings and investment are variables that evolve relatively slowly over time, such as labour force growth and age structure. The conclusions suggest that over the coming years, world real interest rates are likely to continue to adjust slowly, reflecting long-term trends.     

The inflation and inflation uncertainty relationship for Turkey: a dynamic framework

This article assesses the interaction between inflation and inflation uncertainty in a dynamic framework for Turkey by using monthly data for the time period 1984–2009. The bulk of previous studies investigating the link between inflation and inflation uncertainty employ Autoregressive Conditional Heteroskedasticity (ARCH)-type models, which consider inflation uncertainty as a predetermined function of innovations to inflation specification. The stochastic volatility in mean (SVM) models that we use allow for gathering innovations to inflation uncertainty and assess the effect of inflation volatility shocks on inflation over time. When we assess the interaction between inflation and its volatility, the empirical findings indicate that response of inflation to inflation volatility is positive and statistically significant. However, the response of inflation volatility to inflation is negative but not statistically significant.     

The impacts of regime-switching structures and fat-tailed characteristics on the relationship between inflation and inflation uncertainty

A great of deal of study has explored the relationship between inflation and inflation uncertainty under the assumptions of normal distribution and no regime shift. This paper attempts to investigate whether changes in the specification of distribution specification and regime shifts will affect the inflation-uncertainty relationship. Empirical results show that these two factors have a vital effect on the inflation-uncertainty relationship. A specification with four states and the Student’s t distributed error terms can successfully describe the dynamics of the inflation rate. After taking the non-normal density and independent regime shifts into account, this paper finds that inflation uncertainty has no impact on inflation, regardless of inflation pressure. Inflation has a negative impact on inflation uncertainty during periods of high inflation volatility, while the impact of inflation on inflation uncertainty is insignificant during periods of low inflation volatility.     

Food supply and inflation

The paper presents an analytic version of the Latin American structuralist theory of inflation. It emphasizes the difference between the productive sectors of the economy and draws attention to the fact that the inflationary process is closely linked to inconsistent claims for shares in income. It describes a Keynesian economy with two (three) sectors. Real desired wages are rigid. Money is passive. It is shown that the structuralist hypotheses are capable of generating disequilibria that can lead to constantly rising prices without any built in mechanism to offset them. Steady inflation can only persist if workers allow their real wage to be kept below target. As the workers try to catch on, the model will blow up: an accelerating inflation can be observed in many Latin American countries during periods when wage settlements, aimed at restoring inflation losses, escaped the government control. The paper also explores the implications of foreign trade: it shows that, under structuralist hypotheses, external disequilibria cannot be corrected through exchange rate devaluations alone, and it examines the stagflationary impacts of an increase in the price of imported intermediates.     

Catching up: The role of demand, supply and regulated price effects on the real exchange rates of four accession countries

The main aim of this paper is to examine the exchange rate behaviour of a group of four transitional, EU accession countries, with a view to making policy recommendations regarding their full accession to the European Monetary Union. We employ a dynamic OLS panel estimator to investigate the relative importance of demand and supply influences on the exchange rates of these countries. Our analysis shows that both supply‐ and demand‐side effects are important for the accession countries, although their overall effect on inflation differentials and competitiveness seems to be small. An additional focus of the paper is the examination of the role that administrated, or regulated, prices and the productivity of the distribution sector play in the real exchange rate dynamics. Using a unique database we show that administrative prices have been a powerful force behind price and real exchange developments for our group of accession countries. The distribution sector is shown to have an independent effect on the internal price ratio over and above that generated by the Balassa–Samuelson effect.     

Impact of oil price shocks on output,inflation and the real exchange rate: evidence from selected ASEAN countries

This article analyses the impact of oil price shocks on real output, inflation and the real exchange rate in Thailand, Malaysia, Singapore, the Philippines and Indonesia (ASEAN-5) using a Structural VAR model. The cointegration tests indicate that the macroeconomic variables of these countries are cointegrated and share common trends in the long run. The impulse response functions reveal that oil price fluctuations do not impact the ASEAN-5 economies in the long run and much of its effect is absorbed within five to six quarters. The variance decomposition results further assert that with a few exceptions oil price shocks do not explain a significant variation in any of the variables under consideration. We also identify a very unique pattern of response to oil price fluctuations between Malaysia and Singapore and between the Philippines and Thailand. The pairs exhibit a high degree of similarity in their responses; they do not share any commonalities across the group.