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Macroeconomic Uncertainty and Performance in the European Union and Implications for the objectives of Monetary Policy

We use a very general bivariate GARCH-M model and monthly data on EU countries covering the 1962-2003 period to test for the impact of real (output growth) and nominal (inflation) macroeconomic uncertainty on inflation and output growth. Our evidence supports a number of important conclusions. First, in the majority of countries uncertainty regarding the output growth rate is related to the average growth rate and the effect in several countries is negative. Second, contrary to expectations, inflation uncertainty in several cases improves the output growth performance of an economy implying that the focus of European monetary policy strategy on stabilising inflation rather than output growth may be misplaced. Third, inflation and output uncertainty have a mixed effect on inflation. Our conclusions are based on adopting both a structural and a reduced form bivariate GARCH model. These results imply that macroeconomic uncertainty may even improve macroeconomic performance. Finally, we also and statistically significant evidence of regime switching for both inflation and output growth volatility throughout the sample.

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Paper provided by Department of Economics, University of Macedonia in its series Discussion Paper Series with number 2008_01.

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Date of creation: Jan 2008
Date of revision: Jan 2008
Handle: RePEc:mcd:mcddps:2008_01
Contact details of provider: Web page: http://www.uom.gr/index.php?tmima=3

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