Uncertainty shocks and inflation: The role of credibility and expectation anchoring

Abstract

This paper focuses on the uncertainty effect on consumer price inflation based on a panel of 82 advanced, emerging, and developing economies studied over a sample period running from 1995 to 2022. In contrast to the previous literature, we particularly control for the role of monetary policy credibility by considering the monetary control classification of Cobham (2021) and by measuring the degree of anchoring of survey inflation expectations. We argue that the interpretation of uncertainty as a negative demand shock is appealing from a theoretical perspective but is unlikely to reflect uncertainty dynamics for countries with high inflation and/or low monetary policy credibility. We find that higher uncertainty boosts inflation. However, this effect is significantly reduced (or even eliminated) by both a strong degree of monetary control and a strong anchoring of inflation expectations, illustrating that both factors are of key importance for the propagation of uncertainty shocks.