TIME-VARYING CAUSALITY IMPACT OF WORLD UNCERTAINTY ON G7 AND F5 COUNTRIES’ INFLATION RATES

Our study explores the causality relationship running from uncertainties to inflation in both G7 and F5 countries by using the largest data set available. We employ World Uncertainty Index (WUI) developed by Ahir et al. (2018) to represent uncertainties. This index differs from other economy-related uncertainties as it is constructed from both major political and economic developments. Since our model parameters are shown to be not stable, we perform time-varying causality analysis. Our results suggest that uncertainties have predictive power on inflation. Second, we also conclude that uncertainties associated with political developments produce price changes at least as much as uncertainties driven by economic developments. This evidence reveals that a stable political environment is also required to reduce inflation rates. Third, even though policy makers successfully recognize the source of uncertainty and conduct national policies against them, reducing inflation rates still can be challenging task for policy makers due to spillover impacts of uncertainties. Finally, causal relationship is more robust in G7 countries as the number of detected causal episodes in G7 countries is substantially higher than F5 countries. This result also implies that changes in uncertainties at different development stages can produce different price responses.