We study the relationship between average inflation and inflation uncertainty in Mexico from 1960-1997. Friedman (1977) and Ball (1992) propose models where higher inflation creates increased uncertainty, whereas Cukierman & Meltzer (1986) and Cukierman (1992) argue that an apportunistic Central Bank will take advantage of higher uncertainty to raise the average inflation rate. We test these theories simultaneously using a GARCH-M model for monthly Mexican inflation. We find that higher inflation causes increased uncertainty as predicted by Friedman and Ball. However, contrary to the models of Cukierman and Meltzer, increased inflation uncertainty is associated with lower rather than higher average inflation. This result, that the Central Bank of Mexico stabilizes inflation to help reduce uncertainty, corresponds with Grier & Perry's (1998) findings for the Central Banks of the USA and Germany.
|Number of pages||20|
|State||Published - 1998|