Evaluating Inflation Uncertainty Indicators: Criteria and Application in a Developing Economy

Abstract

The present study evaluates the performance of a set of indicators in terms of their suitability as an empirical measure of inflation uncertainty in the Brazilian economy from 2003 to 2022. We consider proxies constructed with GARCH and Markov-Switching models, in addition to the dispersion of the market’s inflation expectations, a measure of monetary policy credibility, and the density forecast for future inflation produced by the Brazilian Central Bank. To evaluate these indicators, we propose three criteria, two of them mandatories and one optional: 1) their correlation with inflation and inflation expectations, 2) their impact on macroeconomic indicators, and 3) their countercyclical behavior throughout business cycles, a feature that is most commonly seen in developing countries. The results show that the credibility indicator yields the most satisfactory outcomes, presenting a positive correlation with inflation and its expectations, peaks in recessions,
and impacting the macroeconomic variables in the expected way.