Monetary policy volatility shocks in Brazil

Abstract

This paper provides empirical evidence of the impact of changes in volatility of monetary policy in Brazil using a model where the time-varying volatility of shocks directly affects the level of observed variables. Contrary to the literature, an increase in monetary policy volatility results in higher inflation, combined with reduction in output. Qualitative differences of impulse responses functions are explained using a calibrated small-scale dynamic model, where the habit persistence in consumption, combined with the design of monetary policy, plays a key role in results. Firms tend to increase prices under higher volatility, in order to avoid costs of resetting over time. Working capital constraints amplify the effects of interest rate volatility shocks on prices.