The missing link between inflation uncertainty and interest rates

Date
2005
Advisor
Instructor
Source Title
Scottish Journal of Political Economy
Print ISSN
0036-9292
Electronic ISSN
1467-9485
Publisher
Wiley-Blackwell Publishing Ltd.
Volume
52
Issue
2
Pages
222 - 241
Language
English
Type
Article
Journal Title
Journal ISSN
Volume Title
Abstract

In the literature, there is no consensus about the direction of the effects of inflation uncertainty on interest rates. This paper states that such a result may stem from differentiation in the sources of the uncertainties and analyzes the effects of different types of inflation uncertainties on a set of interest rates for the UK within an interest rate rule framework. Three types of inflation uncertainties - impulse uncertainty, structural uncertainty and steady-state uncertainty - are derived by using a time-varying parameter model with a Generalized Autoregressive Conditional Heteroskedasticity specification. It is shown that the impulse uncertainty is positively and the structural uncertainty is negatively correlated with the interest rates. Moreover, these two uncertainties are important to explain short-term interest rates for the period of inflation targeting era. However, this time, the impulse uncertainty is negatively and the structural uncertainty is positively correlated with the overnight interbank interest rates, which is consistent with the general characteristic of the inflation targeting regimes. Lastly, the evidence concerning the effect of the steady-state inflation uncertainty on interest rates is not conclusive. © Scottish Economic Society 2005.

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Other identifiers
Book Title
Keywords
Banking, Financial market, Inflation, Interest rate, Eastern Hemisphere, Eurasia, Europe, United Kingdom, Western Europe, World
Citation
Published Version (Please cite this version)