On fiscal and monetary policy-induced macroeconomic volatility dynamics

This paper studies macroeconomic volatility dynamics induced by government spending and monetary policy changes. The policy level and volatility shocks, which are identified through sign restrictions from a time-varying SVAR model, are used to derive explicit functions of macroeconomic volatility impulse responses and decompositions. The SVAR model is specified with time-varying coefficients and stochastic volatility that is included in the mean equation. The empirical results show that the impact of a shock to uncertainty about monetary policy explains about 40% and 25% of output and inflation historical volatility dynamics, respectively, more than other policy shocks since the mid-1980s. The impact of a one-unit government spending level shock on output and inflation uncertainties is equivalent to the impact of about a half unit of a monetary policy volatility shock in the long run, or of about a quarter unit of a monetary policy level shock in the short run. (C) 2021 Elsevier B.V. All rights reserved.