Inflation targeting and the inflation-inflation uncertainty relationship: evidence from Thailand

Abstract

This study extends the literature on the relationships between inflation and inflation volatility by examining the impact of inflation targeting on inflation volatility in Thailand. The ARIMA–GARCH model reveals that inflation targeting marginally reduced the degree of volatility persistence in response to inflationary shocks (i.e. inflation uncertainty). Granger-causality tests show that an increase in inflation causes an increase in inflation uncertainty. However, an increase in inflation uncertainty causes a decrease in inflation. Thus, the relationship between inflation and inflation uncertainty in Thailand support Holland's (1995) stabilization hypothesis.

Notes

¹For examples of the debate on this issue, see Dittmar et al. (1999), Cecchetti and Ehrmann (1999), Mishkin (2000), Johnson (2002, 2003), Svensson (2002), Gavin (2003), Berument and Yuksel (2007) and citations therein.

²The criteria outlined draws from Amato and Gerlach (2002, p. 782).

³This brief description of monetary policy actions was obtained from the Bank of Thailand's website www.bot.or.th

⁴The ARCH–GARCH models, advanced by Engle (1982) and Bollerslev (1986), more closely align with the notions of uncertainty as the variance of the unpredictable component of inflation. Studies using ARCH–GARCH models for industrialized economies include Engle (1983), Bollerslev (1986), Cosimano and Jensen (1988), Evans (1991), Brunner and Hess (1993), Caporale and McKiernam (1997), Balcombe (1999), Hwang (2001) and Caporale and Caporale (2002) for the US; Fountas (2001) and Kontonikas (2004) for the UK; Bohara and Sauer (1994) for Germany; Baillie et al. (1996), Grier and Perry (1998), Berument and Dincer (2005) and Henry et al. (2007) for the G7 countries; Fountas et al. (2004) for European Union countries; Conrad and Karanasis (2005) for the US, UK and Japan. Baillie et al. (1996), Nas and Perry (2000), Teltar and Teltar (2003), Daal et al. (2005), Payne (2008) and Thornton (2007, 2008) have examined developing and emerging market economies as well.

⁵ An alternative approach is to simultaneously model inflation and inflation uncertainty by incorporating lagged inflation in the conditional variance equation and the conditional variance in the mean inflation equation. The issue with the simultaneous modelling approach is that inflation may impact inflation uncertainty over a number of periods. Also, lagged inflation in the conditional variance equation can generate problems with the nonnegativity of the variance.