Gold as an inflation hedge in a time-varying coefficient framework

This study analyzes the question whether gold provides the ability of hedging against inflation from a new perspective. Using data for four major economies, namely the USA, the UK, the Euro Area, and Japan, we allow for nonlinearity and discriminate between long-run and time-varying short-run dynamics. Thus, we conduct a Markov-switching vector error correction model (MS-VECM) approach for a sample period ranging from January 1970 to December 2011. Our main findings are threefold: first, we show that gold is partially able to hedge future inflation in the long-run and this ability is stronger for the USA and the UK compared to Japan and the Euro Area. In addition, the adjustment of the general price level is characterized by regime-dependence, implying that the usefulness of gold as an inflation hedge for investors crucially depends on the time horizon. Finally, one regime approximately accounts for times of turbulence while the other roughly corresponds to ‘normal times’.

► We analyze the ability of gold to provide a hedge against inflation for four major economies, discriminating between long-run and time-varying short-run dynamics.
► Gold is only partially able to hedge future inflation in the long-run.
► During short-run periods where no price adjustment is observed, gold is not able to shield a portfolio against inflation.