Components of inflation uncertainty and interest rates : evidence from Australia and New Zealand

Abstract

This paper tests an enhanced version of the Fisher hypothesis for Australia and New Zealand. This is achieved by extracting three components (structural, impulse and steady state) of inflation uncertainty using a structural time series model of inflation that includes an output gap as well. In general, there is a positive association between impulse uncertainty and nominal interest rates and a negative association between structural uncertainty and interest rates. However, the long run effect of inflation on interest rates is less than one and this indicates that Central Banks have some flexibility in their inflation-targeting strategies