The relationship between inflation and inflation uncertainty in Vietnam over the period 1995-2010

Abstract

The study investigates the causal relationship between inflation and inflation uncertainty in Vietnam over the period 1995-2010 using the two-step procedure. Inflation uncertainty is modeled by both symmetric model (GARCH(1,1)) and asymmetric models (TARCH(1,1), PARCH(1,1), EGARCH(1,1)). The results indicate that there exists an asymmetric impact of inflation shocks on inflation uncertainty, implying that a positive inflation shock induces higher inflation uncertainty, while a negative inflation shock induces lower inflation uncertainty. Based on information criteria including AIC, SC, and HQ as well as diagnostic tests, AR(13)-EGARCH(1,1) is considered the best model to model inflation uncertainty. Then Granger causality tests are employed to test the causality between inflation and inflation uncertainty (estimated by the AR(13)-EGARCH(1,1) model). The results support that a rise in inflation significantly leads to more inflation uncertainty, which confirms the Friedman-Ball hypothesis; and increasing inflation uncertainty leads to more inflation, confirming the Cukierman-Meltzer hypothesis, which indicates an “opportunistic” State Bank of Vietnam. The policy implication is that the monetary authorities have to keep inflation low, stable and predictable to eliminate the negative impact of inflation uncertainty.