Are Higher Levels of Inflation Less Predictable? A State-Dependent Conditional Heteroscedasticity Approach

Milton Friedman (1977) proposed that there is a positive relationship between inflation and inflation uncertainty. Using state-dependent models of conditional moments, the authors find strong statistical evidence that higher levels of inflation are less predictable, although innovations in inflation are somewhat bet ter predictors of future volatility than actual inflation. The authors' results are robust to different sample periods and to assumptions about a unit root in inflation. The authors also compare their resul ts to estimates using exponential generalized autoregressive conditiona l heteroskedasticity models, an alternative to state dependent models that also allows for asymmetries but does not nest conventional models.