The unprecedented policy responses during the Global Financial Crisis and European debt crisis may have increased uncertainty about inflation and strengthen the transmission of inflation uncertainty shocks from one country to another. This paper examines empirical methodologies to measure the strength of the interdependence of inflation uncertainty between the UK and the euro area. First, I estimate inflation uncertainty by ex post forecast errors from a bivariate VAR GARCH model and find that the inflation uncertainty exhibits non-Gaussian properties. In such cases, correlations and copulas to measure the interdependence could suffer from bias if endogeneity is not properly addressed. To identify structural parameters in an endogeneity representation of interdependence, I exploit heteroskedasticity in the data across different regimes determined by the ratio of variances. The estimation results corroborate that the strength of the propagation of inflation uncertainty amplifies during the crisis while the interdependence significantly weakens in the post-crisis period.

https://doi.org/10.1007/s10614-024-10635-z