Inflation Volatility and the Directional Volatility Ratio

Abstract

This paper proposes a semiparametric model to estimate inflation volatility under rational inattention and introduces a new inflation risk measure: the directional volatility ratio. We estimate inflation trends and volatility in Germany, France, Spain, the Eurozone, and the USA from January 2002 to July 2023. Our volatility measure outperforms standard inflation volatility forecasting methodologies and relates to subjective inflation volatility. The directional volatility ratio significantly relates to the inflation trend dynamics, foreseeing likely inflation trends and turning points. We recommend using inflation total and directional volatility to monitor and forecast inflation trend dynamics.

Keywords: Inflation Trend, Inflation volaitlitiy, Rational inattention, semivolatilities, directional volatility ratio

JEL Classification: C22, C32, E3, E4, E5