Policy volatility and growth

Abstract

The paper aims to examine how fiscal and monetary volatility might affect the balanced economic growth rate using a standard monetary growth model characterized by nominal wage rigidity and productive public spending. The model shows that any type of shock — monetary or fiscal — can generate either a negative or positive relationship between short-run volatility and long-run growth, critically depending on the size of government and the elasticity of output with respect to labor/capital. In particular, given the labor income share, it shows that excessive government spending may cause the impact of fiscal volatility on long-run growth to turn from positive to negative. In addition, a rise in the volatility of the monetary shock is capable of generating either an increase or decrease in the mean of growth. With the range of the labor share values in reality, the model produces results consistent with the fact that the relationship between volatility and growth is generally found empirically to be more negative in developing than in developed countries. The model can be seen as a further explanation for the ambiguous empirical evidence in the existing literature.

This is a preview of subscription content, log in to check access.

Fig. 1

Notes

  1. 1.

    The assumption that utility is additively separable in consumption, real money balances, and labor supply allows for closed-form solutions. The budget constraint is also written without bond holdings for analytical convenience. For further simplicity, I also abstract from preference or technology shocks, since these shocks have been examined thoroughly in the existing literature.

  2. 2.

    If X and Y are independent random variables, then the second-order Taylor approximation of the expected value of the quotient X/Y is given by \( E\left[\frac{X}{Y}\right]\simeq \left(\frac{E\left[X\right]}{E\left[y\right]}\right)\left(1+\frac{Var\left[Y\right]}{{\left(E\left[Y\right]\right)}^2}\right) \).

References

  1. Afonso A, Furceri D (2010) Government size, composition, volatility and economic growth. Eur J Polit Econ 26:517–532

    Article  Google Scholar 

  2. Aghion P, Howitt P (1992) A model of growth through creative destruction. Econometrica 60(2):323–351

    Article  Google Scholar 

  3. Aghion P, Saint-Paul P (1998a) VIRTUES OF BAD TIMES Interaction Between Productivity Growth and Economic Fluctuations. Macroecon Dyn 2(3):322–344

    Google Scholar 

  4. Aghion P, Saint-Paul P (1998b) Uncovering some causal relationships between productivity growth and the structure of economic fluctuations a tentative survey. Labour CEIS 12(2):279–303

    Article  Google Scholar 

  5. Aizenman J, Marion N (1993) Policy Uncertainty, Persistence and Growth. Rev Int Econ 1(2):145–163

    Article  Google Scholar 

  6. Annicchiarico B, Pelloni A, Rossiet L (2011) Endogenous growth, monetary shocks and nominal rigidities. Econ Lett 113(2):103–107

    Article  Google Scholar 

  7. Barro RJ (1990) Government spending in a simple model of endogenous growth. J Polit Econ 98(5):103–126

    Article  Google Scholar 

  8. Blackburn K, Galindev R (2003) Growth, volatility and learning. Econ Lett 79(3):417–421

    Article  Google Scholar 

  9. Blackburn K, Pelloni A (2004) On the relationship between growth and volatility. Econ Lett 83(1):123–127

    Article  Google Scholar 

  10. Blackburn K, Pelloni A (2005) Growth, cycles, and stabilization policy. Oxf Econ Pap 57(2):262–282

    Article  Google Scholar 

  11. Brunetti A (1998) Policy volatility and economic growth: A comparative, empirical analysis. Eur J Polit Econ 14:35–52

    Article  Google Scholar 

  12. de Hek PA (1999) On endogenous growth under uncertainty. Int Econ Rev 40(3):727–744

    Article  Google Scholar 

  13. Dixit A, Stiglitz J (1977) Monopolistic Competition and Optimum Product Diversity. Am Econ Rev 67(3):297–308

    Google Scholar 

  14. Döpke J (2004) How robust is the empirical link between business-cycle volatility and long-run growth in OECD countries? Int Rev Appl Econ 18(1):103–121

    Article  Google Scholar 

  15. Dotsey M, Sarte PD (2000) Inflation, uncertainty and growth in a cash-in-advance economy. J Monet Econ 45(3):631–655

    Article  Google Scholar 

  16. Fatás A, Mihov I (2013) Policy Volatility, Institutions, and Economic Growth. Rev Econ Stat 95(2):362–376

    Article  Google Scholar 

  17. Grier K, Perry MJ (2000) The effects of real and nominal uncertainty on inflation and output growth some GARCH-M evidence. J Appl Econ 15(1):45–58

    Article  Google Scholar 

  18. Grier K, Tullock G (1989) An empirical analysis of cross sectional economic growth 1951–80. J Monet Econ 24(2):259–276

    Article  Google Scholar 

  19. Hnatkovska V, Loayza N (2004) Volatility and growth. Policy, Research working paper; no. WPS 3184. Washington, DC: World Bank

  20. ILO and OECD (2015) The Labour Share in G20 Economies. International Labour Organization and Organization for Economic Co-operation and Development, Report prepared for the G20 Employment Working Group Antalya, Turkey, 26–27 February 2015

  21. Imbs J (2007) Growth and Volatility. J Monet Econ 54(7):1848–1862

    Article  Google Scholar 

  22. Jetter M (2014) Volatility and growth: Governments are key. Eur J Polit Econ 36:71–88

    Article  Google Scholar 

  23. Jones LE, Manuelli RE, Stacchetti E (1999) Technology (and policy) shocks in models of endogenous growth. Working Paper No. 7063, NBER, Cambridge, MA

  24. Judson R, Orphanides A, (1999) International Finance 2(1): 117–138

  25. Kormendi R, Meguire P (1985) Macroeconomic determinants of growth cross-country evidence. J Monet Econ 16(2):141–163

    Article  Google Scholar 

  26. Loayza N, Rancière R, Servén L, Ventura J (2007) Macroeconomic Volatility and Welfare in Developing Countries. World Bank Econ Rev 21(3):343–357

    Article  Google Scholar 

  27. Martin P, Rogers CA (1997) Stabilization policy, learning-by-doing, and economic growth. Oxf Econ Pap 49(2):152–166

    Article  Google Scholar 

  28. Martin P, Rogers CA (2000) Long-term growth and short-term economic instability. Eur Econ Rev 44(2):359–381

    Article  Google Scholar 

  29. Mirman LJ (1971) Uncertainty and optimal consumption decisions. Econometrica 39(1):179–185

    Article  Google Scholar 

  30. Pham TA (2011) Growth, volatility and stabilization policy in a DSGE model with nominal rigidities and learning-by-doing. IEEP 8(3):307–322

    Article  Google Scholar 

  31. Rankin N (1998) Nominal rigidity and monetary uncertainty. Eur Econ Rev 42(1):185–199

    Article  Google Scholar 

  32. Schumpeter JA, Fels R (1939) Business Cycles, vol 1. Cambridge Univ. Press, Cambridge and New York

    Google Scholar 

  33. Scully GW (2003) Optimal taxation, economic growth and income inequality. Public Choice 115(3–4):299–312

    Article  Google Scholar 

  34. Sheehey E (1993) The effect of government size on economic growth. East Econ J 19(3):321–328

    Google Scholar 

  35. Trapp K (2015) Measuring the labour income share of developing countries. United Nations University World Institute for Development Economic Research (WIDER) Working Paper 2015/041

  36. Varvarigos D (2007) Policy variability, productive spending, and growth. Economica 74(294):299–313

    Article  Google Scholar 

  37. Varvarigos D (2010) Inflation, volatile public spending, and endogenously sustained growth. J Econ Dyn Control 34(10):1893–1906

    Article  Google Scholar 

Download references

Author information

Affiliations

Authors

Corresponding author

Correspondence to The Anh Pham.

About this article

Verify currency and authenticity via CrossMark

Cite this article

Pham, T.A. Policy volatility and growth. Port Econ J 17, 87–97 (2018). https://doi.org/10.1007/s10258-018-0144-6

Download citation

Keywords

  • Growth
  • Volatility
  • Nominal wage rigidity
  • Productive public spending
  • Labor share

JEL classification

  • E32
  • E60
  • O42