The data favors a model with two unspanned volatility factors that capture uncertainty about monetary policy and the term premium. These relationships change over time and we observe large variances in pairwise spillovers during the global financial crisis. Drew Creal gratefully acknowledges financial support from the William Ladany Faculty Scholar Fund at the University of Chicago Booth School of Business. First, end the health crisis. The former’s results are tabulated, while the latter’s results are shown in the figures. Since the rows of \(\vartheta (H)\) do not necessarily sum to one, each element of the variance decomposition matrix can be normalized by the row sum: where \(\sum _{j=1}^{N}{{{\widetilde{\vartheta }}}_{ij} (H)}=1\) and \(\sum _{i,j=1}^{N}{{\widetilde{\vartheta }}_{ij} (H)}=N\). We report the estimation results for monetary policy uncertainty spillovers using the Diebold and Yilmaz (2009, 2012, 2015) (hereafter DY) method in Tables 3, 5, 7, and 9 and the Baruník and Křehlík (2018) (hereafter BK) method in Tables 4, 6, 8, and 10. Monetary Policy and Uncertainty Paul Jenkins, Deputy Governor and David Longworth, Adviser • In formulating monetary policy, central banks must cope with substantial economic uncertainty. The crisis period can be seen at an approximate index of 20 (corresponding to Jan 2009) for the 3-month bond yields and 68 for the 10-year bond yields. Appl Econ Lett 21(13):938–944. This paper was formerly titled “Term Structure of Interest Rate Volatility and Macroeconomic Uncertainty” and “Interest Rate Uncertainty and Economic Fluctuations”. California Privacy Statement, The uncertainty effect of COVID-19 hits … Gabauer and Gupta (2018) found that monetary policy uncertainty in the US drives trade policy uncertainty in Japan and vice versa., Ajmi AN, Gupta R, Kanda P (2014) Causality between economic policy uncertainty across countries: Evidence from linear and nonlinear tests. Rey (2015), through a VAR analysis found that monetary policy in a central country is one of the determinants in a global financial cycle. In the long term, our results show that the total spillover index is \(73.51\%\), indicating that nearly three-quarters of forecast error variance in the long term come from spillovers. In addition to working papers, the NBER disseminates affiliates’ latest findings through a range of free periodicals — the NBER Reporter, the NBER Digest, the Bulletin on Retirement and Disability, and the Bulletin on Health — as well as online conference reports, video lectures, and interviews. (2016), where they searched newspaper articles for keywords. That is why we need continued strong policy action to combat continued uncertainty. Privacy 2016) and Interest Rate Uncertainty, indicating that it can capture uncertainty surrounding monetary policy. In addition, our measure in principle represent uncertainty perceived by a different and potentially broader segment of the population. Second, at high levels of uncertainty a monetary policy surprise has only modest e ects on assets, whereas with low uncertainty the impact is signi cantly more pronounced. For high levels of persistence the opposite becomes true – the optimal monetary policy should be more aggressive than in the full information case, and the degree of aggressiveness should increase as uncertainty becomes larger. J Econ Stud 2:44, Balli F, Uddin GS, Mudassar H, Yoon SM (2017) Cross-country determinants of economic policy uncertainty spillovers. Monetary Policy Uncertainty Abstract We construct new measures of uncertainty about Federal Reserve policy actions and their consequences, monetary policy uncertainty (MPU) indexes. $$\begin{aligned} Y_t= \sum _{i=1}^p \Psi _i Y_{t-i}+\epsilon _t \end{aligned}$$, $$\begin{aligned} Y_t=\sum _{i=0}^{\infty }A_i\varepsilon _{t-i} \end{aligned}$$, \(A_i=\Psi _1A_{i-1}+\Psi _2A_{i-2}+...\Psi _pA_{i-p}\), $$\begin{aligned} \vartheta _{ij}\left( H\right) =\frac{\sigma _{jj}^{-1}\sum _{h=0}^{H-1} \left( e_i^\prime A_h {\Omega }e_j\right) ^2}{\sum _{h=0}^{H-1} \left( \ e_i^\prime A_h {\Omega }{{A^\prime }_he}_i\right) } \end{aligned}$$, $$\begin{aligned} {{\widetilde{\vartheta }}}_{ij} \left( H\right) =\frac{\vartheta _{ij} \left( H\right) }{\sum _{j=1}^{N}{\vartheta _{ij} \left( H\right) }} \end{aligned}$$, \(\sum _{j=1}^{N}{{{\widetilde{\vartheta }}}_{ij} (H)}=1\), \(\sum _{i,j=1}^{N}{{\widetilde{\vartheta }}_{ij} (H)}=N\), \(i, j=1,2,\ldots , N,\ {\text{and}}\ i\ne j\), $$\begin{aligned} C(H) = \frac{\sum ^N_{\begin{array}{c} i,j = 1 \\ i\ne j \end{array}}{{\widetilde{\vartheta }}_{ij}(H)}}{\sum ^N_{i,j = 1}{{\widetilde{\vartheta }}_{ij}(H)}} \times 100 = \frac{\sum ^N_{\begin{array}{c} i,j = 1 \\ i\ne j \end{array}}{{\widetilde{\vartheta }}_{ij}(H)}}{N}\times 100 \end{aligned}$$, $$\begin{aligned} DS_{i\leftarrow j}(H) = \frac{\sum ^N_{\begin{array}{c} j = 1 \\ i\ne j \end{array}}{{\widetilde{\vartheta }}_{ij}(H)}}{N} \times 100 \end{aligned}$$, $$\begin{aligned} DS_{i\rightarrow j}(H) = \frac{\sum ^N_{\begin{array}{c} j = 1 \\ i\ne j \end{array}}{{\widetilde{\vartheta }}_{ji}(H)}}{N} \times 100. Table 1 shows the total spillover index, which is located in the lower right corner of Tables 3, 4, 5, 6, 7, 8, 9 and 10 (in Appendix). Using a DSGE model of the South African Economy, Balcilar et al. Policy makers should consider accounting for the spillovers from the US, Germany, France and Spain, as we found that they are the most consistent net transmitters of monetary policy uncertainty. As suggested by Rey (2015), the developing world could have even less monetary policy discretion than the developed world. J Policy Model 39(6):1052–1064, Balcilar M, Gupta R, Jooste C (2017b) South Africa’s economic response to monetary policy uncertainty. The experience of monetary policy making in an uncertain environment has encouraged increased attention to the concept of model uncertainty, that is, uncertainty as to which is the best model. J Macroecon 57:317–337, Gupta R, Pierdzioch C, Risse M (2016) On international uncertainty links: BART-based empirical evidence for Canada. We investigate the relationship between uncertainty about monetary policy and its transmission mechanism, and economic fluctuations. We calculate the net spillovers from Tables 3, 4, 5, 6, 7, 8, 9 and 10, which provide a decomposition of the total spillovers into those coming from (or going to) other countries. NBER Working Paper Series, No. For example, in the DY results of the 3m3m dataset, the directional spillover index from the US to other countries (\(6.97\%\)) is higher than the spillover index from other countries to the US (\(4.37\%\)), indicating that the US acts as a net transmitter of monetary policy uncertainty. On the other hand, periods of both high uncertaintyand high risk aversion are followed by a looser monetary policy stance but these results are less robust and weaker statistically. The COVID-19 pandemic is influencing the management of monetary policy in its role as regulator of aggregate demand and guarantor of macroeconomic stability. For central banks, such uncertainty makes effective calibration of monetary policy challenging. Econ Lett 58(1):17–29, Rey H (2015) Dilemma not trilemma: the global financial cycle and monetary policy independence. In the presence Econ Lett 121(1):39–42, Çekin SE, Pradhan AK, Tiwari AK, Gupta R (2019) Measuring co-dependencies of economic policy uncertainty in Latin American Countries using vine copulas. Conditional on a monetary policy shock, higher uncertainty about monetary policy tends to make securities with longer maturities relatively more attractive to investors. On average, innovations from Spain are responsible for \(13.59 \%\) of the error variance in forecasting uncertainty of these countries, while only \(1.11 \%\) comes from innovations to Japan. We contribute to the empirical literature by applying two methodologies, not used in uncertainty spillovers for monetary policy, to a new measure for monetary policy uncertainty. Fed President Patrick Harker Forecasts Moderate Growth Through Rest of the Year Patrick T. Harker, president and CEO of the Federal Reserve Bank of Philadelphia, told a virtual audience at the Wharton Private Equity and Venture Capital Alumni Association that he expects moderate economic growth for the rest of this year and the first half of 2021. Gupta et al. Uncertainty contributes negatively to economic activity. uncertainty about monetary policy, including its transmission (Brainard (2017)). We consider bi-directional spillovers and follow the literature in using Diebold and Yilmaz (2009, 2012, 2015). All Rights Reserved. Cite this article. Entry i,j (\(i\ne j\)) in Tables 3, 4, 5, 6, 7, 8, 9 and 10 represents the estimated contribution to the forecast error variance of country j coming from shocks in country i. It then reviews the strategies employed by the Bank to deal with this problem. These relationships are analyzed below. We also find that the US is a net transmitter of uncertainty for most of the samples, but there are some instances where it is a net receiver. The euro area economy is gradually emerging from a deep and protracted downturn. The extent to which individual responses to household surveys are protected from discovery by outside parties depends... © 2020 National Bureau of Economic Research. We examine whether monetary policy uncertainty influences the reaction of the equity, Treasury security, foreign exchange and crude oil markets, as well as medium-term interest rates, to U.S macroeconomic announcements. Balcilar et al. Policy uncertainty (also called regime uncertainty) is a class of economic risk where the future path of government policy is uncertain, raising risk premia and leading businesses and individuals to delay spending and investment until this uncertainty has been resolved. Concerns about policy uncertainty have intensified in the wake of the global financial crisis, serial crises in the Eurozone, and partisan policy disputes in the United States. Figures 1, 2, 3, 4, 5, 6, 7 and 8 present the time-varying behavior of net pairwise spillovers from May 2007, while Figs. 9, 10, 11, 12, 13, 14, 15 and 16 present the same for the 10y3m and 10y12m datasets from May 2003. Open Access This article is licensed under a Creative Commons Attribution 4.0 International License, which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons licence, and indicate if changes were made. Due to data availability, we consider the following periods: for the 3m3m dataset—Jan 1999 to Jul 2015, 3m12m—Jan 1999 to Oct 2014, 10y3m—Jan 1995 to Jul 2015 and for 10y12m—Jan 1995 to Oct 2014. Monetary policy uncertainty quickly dissipated before the December 2015 meeting when the Fed actually raised the interest rate, strongly suggesting that Fed communication strategy was at least somewhat effective. For example, the Federal Open Market Committee (2009) and the International Monetary Fund (IMF) (2012, 2013) suggest that uncertainty about U.S. and European fiscal, regulatory, and monetary policies contributed to a steep economic decline in 2008–2009 and slow recoveries afterward.1 To investigate the role of policy uncertainty we first develo… (2017b) found that monetary policy uncertainty can prolong weak economic activity, by suppressing inflation and output simultaneously, and can at times create unintended consequences. Part of The US transmits the largest spillover, but Spain’s spillovers have a larger mean, with a smaller variance. Doctoral dissertation, Yin L, Han L (2014) Spillovers of macroeconomic uncertainty among major economies. The off-diagonal elements of the variance decomposition matrix \(\vartheta (H)\) give the pairwise spillovers across variables. The Official Journal of the Pan-Pacific Association of Input-Output Studies (PAPAIOS), Journal of Economic Structures Authors: Grégory Claeys, Maria Demertzis, Jan Mazza . The US, Germany, France, and Spain are the most consistent transmitters of monetary policy uncertainty, while Sweden and Japan are the most consistent receivers of uncertainty spillovers. (2015) found evidence of US monetary policy spillovers to the rest of the world when they studied the global financial cycle and world asset markets. The chart below plots the three newspaper-based MPU indices for the United States. We develop a new method to measure economic policy uncertainty and test its dynamic relationship with output, investment, and employment. 2014; Balli et al. Firstly, maintaining low and stable inflation enables organisations and individuals to carry out meaningful financial planning, by reducing overall uncertainty. PubMed Google Scholar. Int Rev Finan Anal 65:101382, Arbatli EC, Davis SJ, Ito A, Miake N, Saito I (2017) Policy uncertainty in Japan. By covariance stationarity, the infinite-order moving average representation (MA) of the VAR (p) model in equation (1) exists and is given as. This is also the case for the other countries as we move to the 10-year bond yield and a longer forecast horizon. Downloadable! In the US, \(60.71\%\) of the error variance in forecasting its uncertainty stems from its own uncertainty. The frequency analysis allows us to look at what happens to the spillovers between countries as time progresses using the full sample before we look at rolling window samples to graph the relationships. They applied a TVP-VAR to a dataset they compiled using the EPU and Arbatli et al. (2019) only looked at spillovers of US monetary policy uncertainty to an array of countries. We find that net pairwise spillover effects are strong during the 2007–2008 Global Financial Crisis and the 2009 European Debt Crisis. The rest of the paper is structured as follows: Sect. 2 presents the data and methodology, Sect. 3 discusses the results and Sect. 4 concludes. 2017; Liow et al. We find that there are large spillovers (compared to own spillovers) for some of the countries. We found that there are MPU spillovers between the countries in our sample. Baruník and Křehlík (2018) employ the spectral representation of GFEVD to define connectedness measures on different frequency bands of interest. Therefore, in the long run, a country’s uncertainty is mainly influenced by its own uncertainty. (2017b) found that monetary policy uncertainty suppresses inflation and output simultaneously, which leads to lower interest rates. The spillovers between the European countries are small in the short and medium terms but large in the long term, in the 3-month bond yields at a 3-month forecast horizon dataset. uncertainty about this path. Despite the US being the central country, as mentioned by Rey (2015), there are some instances where the US is still a net receiver of uncertainty spillovers. We calculate the net movements by subtracting the uncertainty receptions from the transmissions (TO-FROM, in the tables). For the two 10-year bond yield datasets, there is a missing observation for Japan in Jul 2005 and is omitted for all the countries in the 10-year datasets. The suspense around FOMC announcements. NBER Working paper 16397, september. The transmission mechanisms of monetary policy uncertainty are relatively unstudied, with Antonakakis et al. In contrast, BBD seek to quantify concerns monetary policy uncertainty in the United States, regardless of whether those concerns involve U.S. or foreign monetary policy. In the results below we focus on the analysis of the 3m3m dataset, but it can be replicated for all the other datasets. This allows them to account for disagreement among forecasters and the perceived variability of future shocks. The total connectedness increases as the frequency increases in the BK, with the long term being more connected. • Economic uncertainty can arise from different sources: the state of the economy, the nature of economic relationships, and the magnitude Source: Ferrero et al. A, B and C correspond to the different panels in the BK tables in Appendix, where A is the short term (1–4 months), B is the medium term (4–12 months) and C the long term (12+ months), respectively. Our results show that the increase in bond maturity and forecast horizon leads to reduced uncertainty spillovers. We find that the largest spillover indices are from innovations in the country itself; however, there are some instances where spillover indices between countries are large. 2014; Yin et al. The monetary policy in the central country (currently the US) affects capital flows, credit growth in the international financial system and the leverage of global banks. PE 626.100 - November 2018 EN IN-DEPTH ANALYSIS, DOI: Fed monetary policy decisions are … Risk, uncertainty and monetary policy. Monetary policy response to uncertainty The Reserve Bank can contribute to a stable economic environment by continuing to focus on fulfilling its dual-mandate. Correspondence to The pairwise spillovers in the US show that, after the crisis, there are instances where this factor is a negative net transmitter (i.e., a net receiver) of uncertainty. The difference in start dates is due to the different time periods for the different datasets. These two results create a problem for policy makers: they cannot simply dust consider just their own countries’ policy uncertainty, and now also have to account for the uncertainties in other countries. We extend our approach to other countries, finding elevated levels of economic policy uncertainty abroad, as well. statement and This is expected, as they have the same monetary authority (except the UK). The methodology calculates a spillover index in the generalized VAR setting of Pesaran and Shin (1998) in which forecast error variance decomposition is independent of variable ordering. As our sample of countries is small due to data availability, it would be interesting to see how the results change when a greater number of developing countries were included. Studying uncertainty and understanding the dynamics behind it gives more information to decision makers, which can reduce risk. MPU is thus an important aspect to consider, as it could foreshadow problems or potential gains. Compared to related measures constructed by Baker, Bloom, and Davis (2015) that are global in nature, our U.S. MPU measure is U.S. centric and focuses on uncertainty related to Fed monetary policy. The methodology uses generalized forecast error variance decomposition to identify bi-directional spillovers, where the GARCH-in-mean VAR used by Nsafoah et al. We investigate the spillovers between countries resulting from monetary policy uncertainty and test whether the aforementioned only holds for spillovers from the US to the rest of the world. Hence, uncertainty measures reflect not only uncertainty about future monetary policy, but also uncertainty about future bank funding conditions and financial market stress. Struct Change Econ Dyn 52:167–173, Gupta R, Ma J, Risse M, Wohar ME (2018) Common business cycles and volatilities in US states and MSAs: the role of economic uncertainty. In some instances, the US becomes a net receiver of uncertainty, such as after the GFC in particular. et al. Most of the relationships are more stable after the GFC. In this study, we use the Interest Rate Uncertainty measure from Istrefi and Mouabbi (2018) to look at monetary policy uncertainty (MPU) spillovers between the US, Germany, France, Italy, Spain, UK, Japan, Canada, and Sweden in both the time and frequency domains. We use the Interest Rate Uncertainty (IRU) index created by Istrefi and Mouabbi (2018) as a measure of monetary policy uncertainty. Rey (2016) argued that the modern global financial cycle challenges the Mundellian trilemma since the exchange rate of a country is more important when it comes to maintaining a stable level.
2020 monetary policy uncertainty