Inflation and its predictability in high‐inflation Latin American countries: Some evidence on two competing hypotheses – a research note

Abstract In this paper we argue that the relationship between inflation and the accuracy of inflation predictions in high‐inflation countries, such as those in Latin America, is ambiguous. Several empirical studies have measured a positive link between the level of inflation and its variability, suggesting that inflation uncertainty rises with the level of inflation. Others have noted, however, that variability measures may not capture uncertainty and that the evidence on a positive relationship between inflation and its uncertainty is weak. In fact, the relationship could, in principle, be negative and we present here some evidence from Latin America that supports partially this latter view. The reason for the potentially negative effect of inflation on inflation uncertainty is that in a high‐inflation environment economic agents invest more resources in generating accurate inflation forecasts and in developing instruments capable of reducing the uncertainty costs of high inflation. In general, however, there is no clear relationship between inflation and its predictability.