Modelling inflation volatility

Eisenstat, Eric and Strachan, Rodney W. (2015) Modelling inflation volatility. Journal of Applied Econometrics, 31 5: 805-820. doi:10.1002/jae.2469

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Author Eisenstat, Eric
Strachan, Rodney W.
Title Modelling inflation volatility
Journal name Journal of Applied Econometrics   Check publisher's open access policy
ISSN 0883-7252
Publication date 2015-05-29
Year available 2015
Sub-type Article (original research)
DOI 10.1002/jae.2469
Open Access Status Not Open Access
Volume 31
Issue 5
Start page 805
End page 820
Total pages 16
Place of publication Chichester, West Sussex, United Kingdom
Publisher John Wiley & Sons
Language eng
Formatted abstract
This paper discusses estimation of US inflation volatility using time-varying parameter models, in particular whether it should be modelled as a stationary or random walk stochastic process. Specifying inflation volatility as an unbounded process, as implied by the random walk, conflicts with priors beliefs, yet a stationary process cannot capture the low-frequency behaviour commonly observed in estimates of volatility. We therefore propose an alternative model with a change-point process in the volatility that allows for switches between stationary models to capture changes in the level and dynamics over the past 40 years. To accommodate the stationarity restriction, we develop a new representation that is equivalent to our model but is computationally more efficient. All models produce effectively identical estimates of volatility, but the change-point model provides more information on the level and persistence of volatility and the probabilities of changes. For example, we find a few well-defined switches in the volatility process and, interestingly, these switches line up well with economic slowdowns or changes of the Federal Reserve Chair. Moreover, a decomposition of inflation shocks into permanent and transitory components shows that a spike in volatility in the late 2000s was entirely on the transitory side and characterized by a rise above its long-run mean level during a period of higher persistence.
Keyword Inflation volatility
Monetary policy
Time varying parameter model
Bayesian estimation
Change-point model
Q-Index Code C1
Q-Index Status Provisional Code
Institutional Status UQ

Document type: Journal Article
Sub-type: Article (original research)
Collections: Official 2016 Collection
School of Economics Publications
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Created: Sun, 24 Jan 2016, 00:37:38 EST by Eric Eisenstat on behalf of School of Economics