The Causal Linkage Between Inflation and Inflation Uncertainty under Structural Breaks: Evidence from Turkey

Abstract

The goal of this paper is to examine the relationship between inflation and inflation uncertainty for Turkey through monthly data spanning the period 2004:01-2019:12. To this end, the paper first builds the inflation uncertainty series using inflation data. Second, it examines the cointegration relationship between inflation and inflation uncertainty. Finally, it searches for causal relationships between inflation and inflation uncertainty. The paper employs econometric methods which explicitly consider structural breaks. After examining the inflation-inflation uncertainty nexus for the whole sample, the analysis also investigates this relationship in two subperiods, i.e., 2004:5-2010:10 and 2010:11:2019:12 considering the change in the monetary policy framework of the Central Bank of the Republic of Turkey (CBRT). The findings provide evidence that there exists unidirectional causality running from inflation to inflation uncertainty for both the whole sample and the second subperiod, while there is no causality between inflation and inflation uncertainty for the first subperiod. Overall, the results show that during the second subperiod (i) when the CBRT tried to achieve not only price stability, but also financial stability and (ii) when the inflation rate is more volatile and higher, the increase in the inflation rate results in an increase in inflation uncertainty.