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The Inflation‐Output Variability Tradeoff and Monetary Policy: Evidence from a GARCH Model

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  • Jim Lee

Abstract

This paper empirically investigates the Taylor curve volatility tradeoff in light of the stochastic behavior of the conditional variances of output and inflation. Stressing structural instability between periods before and after the 1979‐1982 monetary policy regime change, I implement a bivariate generalized autoregressive conditional heteroskedasticity model to capture the output‐inflation variability tradeoff and to explore the plausible impact of a change in the federal funds rate on the two conditional volatilities. I further evaluate the impacts of anticipated and unanticipated policy actions measured by two alternative policy reaction functions—one from a vector‐autoregression‐based reduced‐form equation and another based on the Taylor rule. In addition to showing a volatility tradeoff relationship, the empirical model reveals different magnitudes of policy effects on output and inflation volatility across the two sample periods.

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  • Jim Lee, 2002. "The Inflation‐Output Variability Tradeoff and Monetary Policy: Evidence from a GARCH Model," Southern Economic Journal, John Wiley & Sons, vol. 69(1), pages 175-188, July.
    • Handle: RePEc:wly:soecon:v:69:y:2002:i:1:p:175-188
    DOI: 10.1002/j.2325-8012.2002.tb00484.x
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    1. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(1), pages 122-150, February.
    2. Lee, Jim, 1999. "The inflation and output variability tradeoff: evidence from a Garch model," Economics Letters, Elsevier, vol. 62(1), pages 63-67, January.
    3. Ben S. Bernanke & Ilian Mihov, 1998. "Measuring Monetary Policy," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 113(3), pages 869-902.
    4. Taylor, John B, 1979. "Estimation and Control of a Macroeconomic Model with Rational Expectations," Econometrica, Econometric Society, vol. 47(5), pages 1267-1286, September.
    5. Bernanke, Ben S & Blinder, Alan S, 1992. "The Federal Funds Rate and the Channels of Monetary Transmission," American Economic Review, American Economic Association, vol. 82(4), pages 901-921, September.
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    7. Engle, Robert F, 1983. "Estimates of the Variance of U.S. Inflation Based upon the ARCH Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 15(3), pages 286-301, August.
    8. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 33(1), pages 125-132.
    9. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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