A1493
Title: Inflation uncertainty and higher moments effects on Inflation
Authors: Christos Savva - Cyprus University of Technology (Cyprus) [presenting]
Demetris Koursaros - Cyprus University of Technology (Cyprus)
Nektarios Michail - Central Bank of Cyprus (Cyprus)
Abstract: A new framework is developed to examine the two-way relationship between inflation and inflation uncertainty. Inflation uncertainty matters because when people are unsure about future prices, it influences wage negotiations, investment, and the credibility of monetary policy. To capture these dynamics, we adapt a flexible econometric model used initially in asset pricing to inflation. In our model, inflation depends on past inflation, inflation expectations, and the unemployment gap, while also being influenced by its own volatility and risk. Volatility is modeled using an advanced GARCH process that accounts for asymmetry and the possibility of sudden shocks. Higher-order features of the distribution, such as skewness and fat tails, are allowed to evolve over time, meaning that the model can capture both calm and turbulent periods. A key innovation is the distinction between the pure risk effect of uncertainty, which arises from volatility, and the skewness premium, which reflects how extreme shocks affect expected inflation. By combining these elements, the model shows how uncertainty not only responds to inflation but also feeds back into its expected path. This framework offers policymakers and researchers a clearer understanding of how inflation risk shapes economic outcomes and helps inform more effective monetary strategies.
