Is the relationship between inflation and its uncertainty linear?

Abstract

We use parametric power ARCH models of the conditional variance of inflation to model the relationship between inflation and its uncertainty using monthly data for Germany, the Netherlands and Sweden over a period ranging from 1962 to 2004. For all three countries in flation signifi cantly raises infl ation uncertainty as predicted by Friedman. Increased uncertainty affects infl ation in all countries but not in the same manner. For Sweden we fi nd a negative impact in accordance with the Holland hypothesis, whereas for Germany and the Netherlands we fi nd the opposite in support of the Cukierman-Meltzer hypothesis. In a sensitivity analysis we show that an arbitrary choice of the heteroskedasticity parameter in uences this relationship signifi cantly.