A Study On Inlfation Uncertainty, Inlfation Expectation And Inflation Cost

For many governments worldwide, maintaining social harmony, peace, security,and an improvement in the standard of living of their citizens are their utmost concern.However, as it stands presently, economies around the world are facing rapidincreases in commodity prices, huge unemployment and even higher taxes. In somecountries this rapid hike in prices have wipeout up to halve the income earned byhousehold on food and other necessities. Thus living the vast majority of people onfixed income like pensioners and those on state benefit unable to meet their otherneeds, hence they face a decline in their living standards.As inflation persist, more and more people around the world are seeing areduction in both their revenue earned and their living standard. This had in manyplaces lead to social unrest, revolutions and an increase in crime rate. Inflation is seenas a breeding ground for instability, as it affect wages, prices, interest rate,investments and unemployment, which are the back bone of any economy. Therefore,curbing inflation to an acceptable rate and be able to reduce the uncertainty aboutinflation, while at the same time predict future inflation accurately is the number oneinterest of governments and policymakers.Our concept of Inflation, it expectation, it uncertainty and it cost, is based on ourexperience and knowledge of the subject matter, and I therefore see the important ofthis work to future researchers that may be interested in carrying out similar study.The work breaks fresh ground in many directions including:Develop reasonable econometric models that are used to calculate andestimate expected inflation, uncertainty about inflation and the cost of inflation to aneconomy.Estimate in welfare terms, the cost that inflation, expectation and uncertaintyimpose on the economyOutline the causes of inflation and inflation uncertainty in an economy andmake reasonable suggestions on how to prevent and control inflation.Show the relationship between Inflation and uncertainty as well as thatbetween Inflation and expectation.This work comprises a total of six chapters. Chapters one and two accounted for an introduction of the concept of inflation, and the relevant literatures and empiricalstudies on the subject matter. Chapters three, four and five covers in detail inflationuncertainty, inflation expectation and inflation cost respectively. For inflationuncertainty we employ the two steps approach where the conditional variance isestimated first using the generalized autoregressive conditional heteroscedasticity(GARCH) class of models, which allow the conditional variance of the error term tobe time-varying, and then included in the conditional mean equation to carry outcausality test. For inflation expectation, we use a structural VAR model and impose anonrecursive restriction, which enables us to incorporate the interaction betweeninflation and inflation expectations and assess the determinants of inflationexpectations. Moreover, for inflation cost, this work followed Bailey (1956) andFriedman (1969) and use the semi-log functional form of the money demand functionin the estimation of the welfare cost of inflation. Finally, in chapter six, somediscussions, conclusions and recommendations are made about the findings of theprevious three chapters.We find overwhelming evidence that increased inflation significantly raisesinflation uncertainty in China; thus, the strong evidence of causality running frominflation to inflation uncertainty. Our analysis suggests that the monetary authoritymight be able to achieve lower inflation uncertainty by maintaining low and stableinflation, since inflation granger cause inflation uncertainty.Furthermore, improved knowledge of how inflation expectations react to changesin macroeconomic variables can serve as useful input in models describing theinflation process. The results indicate that expected inflation moves in an intuitivemanner in response to shocks in all the VAR variables. We noted found that, shocksto actual inflation, Money supply and output growth together account forapproximately76percent of the variability of expected inflation throughout thesample period.Our calculation shows that there is an increasing marginal welfare cost ofinflation. And that the present6%level of inflation is costing up to2%of incomeearned by individuals in the economy. On the money demand behaviour, our resultshows that as inflation approaches zero per cent, the money demand increases andreaches a satiation point.Finally we recommend that the number one interest of government andpolicymakers should be, towards pursuing a policy of price stability which will lead to better anchoring of inflation and hence curbing inflation to an acceptable rate whichwill reduce the uncertainty about inflation, while at the same time improve predictingfuture inflation accurately.