Inflation Costs, Uncertainty Costs and Emerging Markets

Samuel Schreyer, St Cloud State University

Abstract

Given the costs to real output that inflation uncertainty has been shown to impose, two recent papers have investigated the interaction of inflation and uncertainty for a group of emerging market nations. Both papers find that an increase in inflation almost invariably increases uncertainty in developing countries. This finding accords with the Friedman hypothesis, and with most results for industrialized countries. However, there is both theory and some tentative empirical evidence suggesting that, when inflation is high, and thus costly, an increase in inflation can spur greater investment in predicting the path of prices, and actually reduce, rather than increase uncertainty. This possibility is particularly relevant for emerging markets, some of which have histories of high inflation. Using a somewhat different empirical methodology than previous authors, we find that inflation does indeed lower uncertainty at some horizons, and, as per theory, does so predominantly in those countries in our sample with the higher rates of inflation.