405. Regime-Shifts & Post-Float Inflation Dynamics In Australia

Neil Dias Karunaratne, Ramprasad Bhar, School of Economics Discussion Paper No. 405, March 2010, School of Economics, The University of Queensland. Australia.

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Abstract

Australia’s inflation rate and inflation uncertainty during the post-float era 1983Q3-2006Q4 have acted as important barometers of Australia’s macroeconomic performance. The conceptualisation and measurement of the nexus between inflation and inflation uncertainty is subject to complex dynamics. We use Markov regime switching heteroscedasticity (MRSH) model to capture long-run stochastic trend and short-run noisy components. This allows us to conclude that in post-float Australia the results deviate significantly from the mainstream Friedman paradigm on inflation and its uncertainty. We also critically review the plausibility of rival paradigm explaining this paradoxical behaviour. The regime shifts detected in the inflation dynamics appear to be linked to the macroeconomic policies pursued to achieve external and internal balance as implied by Keynesian Mundell-Fleming model.