Causes and effects of time-dependent inflation uncertainty - measurement, evidence, and policy implications

• Applicant: Professor Dr. Helmut Herwartz
• Subject Area: Statistics and Econometrics
• Term: from 2009 to 2018
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 157678884

The uncertainty regarding the future development of inflation is associated with high economic costs. In an uncertain inflation environment, long-term investment decisions are delayed or distorted in favor of real assets. Moreover, inflation uncertainty increases volatility of relative prices and masks structural price signals. The risks of nominal financial and wage contracts rise and may cause unanticipated redistributions of nominal assets.Based on the results of the first part of the project (e.g., measurement of inflation uncertainty, interplay between inflation uncertainty and inflation as well as growth, uncertainty indicators as explanatory factors for speculative bubbles), we now aim at investigating the origins and effects of inflation uncertainty in greater depth. A main goal is to analyze the extent to which inflation uncertainty affects relationships of, and interactions between, key economic variables identified in the literature. In particular, it seems likely that increased uncertainty systematically changes the transmission of shocks that occur in macroeconomics and financial markets.As in the first part of the project, we focus on three themes. Concerning the measurement of inflation uncertainty, a disaggregated approach will be employed to better understand how inflation uncertainty originates and how it spreads across product groups and countries. In addition, the relationship to broader indicators of macroeconomic uncertainty should be clarified. With respect to the interaction between inflation uncertainty and the macroeconomic environment, we focus on the role inflation uncertainty plays in the interplay of monetary policy, expectation formation, and the business cycle. We start from the well-documented state dependence of expectation formation, which suggests an effect of inflation uncertainty on inflation expectations. Especially in the light of the current developments in the euro area, we ask how monetary policy reacts to inflation uncertainty. Finally, we investigate the interaction between inflation uncertainty and financial markets concentrating on the influence inflation uncertainty has on the transmission mechanisms at financial markets. For example, it may affect the yield curve and the interest rate pass through from the central bank rate to loan and savings rates. Also, it is likely to spill over to other asset classes.As far as possible, we will study the research questions from an international comparative perspective. This will help to assess the sensitivity of the results with respect to country-specific circumstances and to compare different macroeconomic policies.

• DFG Programme: Research Grants