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The Relative Importance of Monetary Policy, Uncertainty, and Financial Shocks

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Abstract

Motivated by recent research suggesting that uncertainty and financial shocks have become the most important sources of business cycle fluctuations, we assess the relative importance of monetary policy, uncertainty, and financial shocks in explaining key macroeconomic variations. Using a Bayesian monetary structural vector autoregressive model augmented with measures of uncertainty and tightness of financial conditions, we identify monetary policy, uncertainty, and financial shocks based on a penalty function approach. We find that uncertainty shocks have become a relatively more important source of output fluctuations than traditional monetary policy shocks and financial shocks. We also find that monetary policy shocks outperform uncertainty and financial shocks in explaining inflation dynamics and that financial shocks are relatively more important than monetary policy and uncertainty shocks in explaining the swings in the stock market. However, these shocks are not the major driver of exchange rates.

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Notes

  1. Our results are identical if the restrictions are binding for as short as 2 months or as long as 6 months.

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Acknowledgments

We would like to thank the Editor, George Tavlas, and an anonymous referee for comments that greatly improved the paper

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  1. Department of Economics, University of Calgary, Calgary, AB, T2N 1N4, Canada

    Cosmas Dery & Apostolos Serletis

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  1. Cosmas Dery
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  2. Apostolos Serletis
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Correspondence to Apostolos Serletis.

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Dery, C., Serletis, A. The Relative Importance of Monetary Policy, Uncertainty, and Financial Shocks. Open Econ Rev 32, 311–333 (2021). https://doi.org/10.1007/s11079-020-09602-6

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