Monetary Volatility Research Articles

Endogenous growth, monetary shocks and nominal rigidities

We introduce endogenous growth in a standard NK model with staggered prices and wages. We find that the source of nominal rigidities, the shock persistence and the type of Taylor rule affect the relationship between monetary volatility and growth.

When Does Uncovered Interest Parity Hold?

A consensus is emerging that returns to the currency carry trade are driven by two factors. One of these is clearly consumption risk but there is disagreement about the identity of the remaining factor. This paper bolsters the case for volatility being the unknown factor. A structural model that specifies that monetary volatility is the second factor is tested for 42 monetary regimes using the artificial economy methodology. The negative slope in the Fama regression arises when monetary volatility is low and the precautionary savings motive dominates the intertemporal substitution motive. When monetary volatility is high, the Fama slope is positive in line with uncovered interest parity. We conclude that, given the predominance of precautionary savings, the degree of monetary volatility explains whether uncovered interest parity holds.

External Monetary Shocks and Monetary Integration: Evidence from the Bulgarian Currency Board

Starting July the 1st 1997, Bulgaria adopted a Currency Board (CB) monetary system. This paper aims at investigating if the adoption of the CB monetary system, which involves the cost of loosing monetary autonomy, has provided a relatively better (with respect to other CEEC) monetary integration of Bulgaria with the European Monetary Union (EMU). Since Bulgarian monetary variables are endogenous under a CB, we focus on the ECB and FED interest rates as the main sources on monetary volatility. First, we find that ECB shocks are more rapidly absorbed and have less significant impact of domestic variables, with respect to other external monetary shocks (FED rate changes). Second, the responses of Bulgarian variables following changes in the ECB interest rate present lower persistence and significance, with respect to what the previous literature emphasized for other CEEC with monetary autonomy. This latter result still holds when accounting for different sources of cross-country heterogeneity outlined in the literature, thus supporting that the adoption of the CB may have worked as a rather good device in terms of integration of Bulgaria into the EMU.

Endogenous Growth, Monetary Shocks and Nominal Rigidities

We introduce endogenous growth in an otherwise standard NK model with staggered prices and wages. Some results follow: (i) monetary volatility negatively affects long-run growth; (ii) the relation between nominal volatility and growth depends on the persistence of the nominal shocks and on the Taylor rule considered; (iii) a Taylor rule with smoothing increases the negative effect of nominal volatility on mean growth.

Sovereign Indebtedness, Default, and Gambling for Redemption

Developing country politicians, faced with the specter of losing office following a costly default, may be tempted to ‘gamble for redemption’ by instituting policies that increase the volatility of output growth, possibly at the expense of reducing average growth. We present a simple model of debt overhang that captures this intuition. Empirically, we demonstrate that sovereign defaults are significantly associated with an increased probability of job loss by political leaders: after controlling for other determinants, the quantitative effect of a default on the probability of job loss is comparable to a 3.5 standard deviation fall in economic growth. Cross country regressions reveal that, as predicted by our model, higher indebtedness is associated with higher monetary, fiscal, and public investment policy volatility and with policies that increase output volatility at the expense of growth.

Welfare cost of inflation in a stochastic balanced growth model

There is a large and growing literature on the welfare cost of inflation. However, work in this area tend to find moderate estimates of welfare gains. In this paper we reexamine welfare costs of inflation within a stochastic general equilibrium balanced growth model paying a particular attention to recursive utility, portfolio balance effects, and monetary volatility and monetary policy uncertainty. Our numerical analysis shows that a monetary policy that brings down inflation to the optimum level can have substantial welfare effects. Portfolio adjustment effects seem to be the dominant factor behind the welfare gains.

Monetary Policy Regime Shifts and Inflation Persistence

This paper reports the results of estimating a Markov-Switching New Keynesian (MSNK) model using Bayesian methods. The broadest and best fitting MSNK model is a four-regime model allowing independent changes in the regimes governing monetary policy and the volatility of the shocks. We use the estimates to investigate the mechanisms that lead to a decline in the persistence of inflation. We show that the population moment describing the serial correlation of inflation is a weighted average of the autocorrelation parameters of the exogenous shocks. Changes in the monetary or shock volatility regimes shift weight over these serial correlation parameters and affect the serial correlation properties of inflation. Estimation results indicate that a shift to a monetary regime that reacts more aggressively to inflation reduces the weight on the more persistent shocks, so lowers inflation persistence. Similarly, a shift to the low-volatility regime reduces the weight on the more persistent shocks and also contributes to reducing inflation persistence. Estimates of model-implied inflation persistence indicate that it began rising in the late 1960s and peaked around the Volcker disinflation. The subsequent decline in persistence is due to both a more aggressive monetary policy regime and less volatile shocks.

Modelling international capital structure under foreign macroeconomic volatility

In the last decade we have witnessed a significant change in the structure of capital flows to developed as well as to developing countries. We construct a simple econometric framework where country-specific random effects and macroeconomic monetary volatility are linked to the probability distribution of liquidity shocks hitting an international investor. A “volatility augmented” gravity equation is then estimated to provide empirical evidence that as the probability of getting a bad liquidity shock increases, investors switch to safer assets but with a pecking order: they seem to damp equities for more bonds and more direct investments. A flight to quality!

Financial intermediary development and growth volatility: Do intermediaries dampen or magnify shocks?

We assess the channels through which financial intermediaries affect economic volatility. Building on Bacchetta and Caminal (2000, Do capital market imperfections exacerbate output fluctuations? European Economic Review 44(3), 449–468) our theoretical model predicts that well-developed financial intermediaries dampen the effect of real sector shocks and magnify the effect of monetary shocks. Using a panel of 63 countries over the period 1960–1997 and using the volatility of terms of trade and inflation to proxy for real and monetary volatility, respectively, we find (i) weak evidence that financial intermediaries dampen the effect of terms of trade volatility, and (ii) some evidence that financial intermediaries magnify the impact of inflation volatility in countries where firms have little or no access to external finance through capital markets.

The effects of circulatory capitalism on democratization: Observations from South Africa and Brazil

This article argues that the democratization processes taking place in South Africa and elsewhere in emerging market economies cannot be separated from the global economic context within which these processes are taking place. The article illustrates that the mainstream political economy literature has not paid sufficient attention to the issue of the limits and constraints placed upon these newly emerging democracies by the new financial architecture, particularly the derivatives market, which now determines the value and price of emerging market currencies. The article concludes that the workings of this market not only heavily favour the interests of developed countries but that they deeply question the accountability of politicians in those emerging markets and thereby endanger the legitimacy of the democratic project in large parts of the post-colonial world. The article is divided into three sections: first, a critique of some of the leading political economy analyses and their position on the relationship between open-economy policies and democracy; second, an account of the development of the derivatives market since 1973 and a theorization of its implications for currency movements, particularly monetary volatility, of emerging market currencies; third, an illustration by way of the South African and Brazilian cases of the policy implications of currency volatility for creating improved social and economic conditions.

Money volatility and output volatility: any asymmetric effects?

PurposeTo investigate whether monetary volatility in the US exerts any asymmetric impact on output volatility over the period 1974‐2002.Design/methodology/approachFor the empirical purposes, the analysis makes use of the multi‐variable GARCH (MVGARCH), which allows not only the presence of volatility clustering but also the presence of asymmetries in that volatility clustering.FindingsThe empirical findings suggest that money supply volatility exerts a significant asymmetric influence on output volatility, i.e. the variance of output changes more due to positive changes than negative changes of money supply volatility.Originality/valueThe paper investigates, for the first time, the presence of any asymmetric impact of the volatility of money on the volatility of output in the case of the US.

Examining the relationship between money uncertainty and inflation in Taiwan

The paper uses monthly data of money and consumer price index from January 1988 to December 1998 for Taiwan. We use GARCH(1, 1) models to generate our measure of money volatility and then test the short-run dynamic relationship between money volatility and inflation, instead of money and inflation. From our empirical results, we may reasonable conclude money volatility has significant, and positive effect on inflation. Furthermore, from the extensive study of impulse response functions, the results reveal that inflation reacts immediately and dramatically for monetary volatility shocks, which are also different from monetary shocks on inflation. It reveals that stable monetary policy will be better for economy, since uncertainty of money will cause inflation and fluctuation of economy.

The Forex Regime and EMU Expansion

This paper provides empirical evidence that, irrespective of the foreign exchange rate regime, countries with high monetary volatility have lower relative output growth rates. It is argued that due to the forward looking nature of the foreign exchange market, exchange rate stability hinges on the stability of the institutional structure within which monetary and fiscal policies are formulated. Subsequently, the likely endogenous response in the accession countries upon entry into EU and EMU is examined. This provides arguments for a rapid transition phase, possibly complemented by a one sided euroisation as a commitment device.

Growth and Welfare Effects of Monetary Volatility

In this paper we use a continuous‐time, stochastic, dynamic general equilibrium model to provide estimates of the growth and welfare effects of monetary volatility. Our primary concern is to highlight the long‐run consequences of different monetary environments in a small open economy. Using UK‐relevant data to set key parameter values in the model, we carry out three policy experiments. We find that (i) eliminating monetary growth shocks and (ii) reducing the inflation rate can each generate positive growth and welfare effects, while (iii) reducing the interest rate depresses growth and is welfare deteriorating. However, these results are sensitive to the values set for the risk aversion and intertemporal substitution parameters. Most notably, in some cases, high degrees of risk aversion are sufficient to change the direction of the influence of volatility on growth and welfare—an issue currently challenging the profession.

Policy volatility and economic growth: A comparative, empirical analysis

This paper provides a comparative test of different measures of policy volatility in cross-country growth regressions. All variables are tested in the same basic specifications and a number of sensitivity checks of the results are performed. Policy volatility is measured either as the standard deviation, the coefficient of variation or the standard errors of autoregressive processes of macroeconomic variables. The analysis shows that, regardless of the particular indicator used, such measures of fiscal and monetary volatility are negatively and often significantly related to cross-country differences in economic growth. In many cases, however, this relationship proves to be rather sensitive to variations in country samples and to variations in the specifications of the growth regression estimated.

Monetary volatility and real output volatility: An empirical model of the financial transmission mechanism in Australia

This paper examines how monetary volatility is transmitted to the volatility of financial asset prices, inflation and real output in an open economy. A Markowitz efficient portfolio is constructed to eliminate diversifiable financial risk, and estimation by GLS on monthly Australian data from 1972(1)–1994(1) using the general-to-specific estimation strategy overcomes the generated regressors problem in related ARCH-type models. The findings include: first, higher monetary volatility is associated with lower volatility of financial asset prices and higher real output volatility, and second, monetary volatility is transmitted to real output volatility predominantly through the share market with no foreign exchange market effect.

Monetary volatility, real volatility, and real exchange rate

Monetary volatility, real volatility, and real exchange rate

Asset Substitution and Monetary Volatility

This paper investigates the question as to whether the volatility of the monetary aggregates arises primarily from the behavior of the monetary base or the monetary multipliers. The findings indicate that the monetary multipliers are more volatile than the base, regardless of the definition of money. The multiplier is substantially more volatile than the m2 or m3 multipliers. Analysis of multiplier's component ratios indicates high volatility of individual components. However, the m2 and m3 multipliers, hence the M2 and M3 aggregates, internalize the movements of volatile individual components. Copyright 1991 by Ohio State University Press.

Interest rates, uncertainty, and monetary volatility

Interest rates, uncertainty, and monetary volatility