A re-examination of growth and growth uncertainty relationship in a stochastic volatility in the mean model with time-varying parameters

Abstract

By means of stochastic volatility in the mean model to allow for time-varying parameters in the conditional mean and quarterly data for the G7 countries, this article examines the dynamic nexus between the volatility of output and economic growth for the G7 countries. This approach allows us to model parameter time-variation so as to reflect changes in the effect of volatility appearing in both the conditional mean and the conditional variance. The evidence in this article indicates that the effect of output volatility on output growth is strongly time-varying and quite analogues for all the G7 countries, with a break around 1973. The effect of output volatility on growth becomes more negative after 1973, with negative and statistically significant estimates after 1973 or early 1990s. Our estimates show a reversal of the declining trend and a significant increase in output volatility in the late-2000s, indicating that the Subprime Crisis brought a temporary break in the Great Moderation. However, the Great Moderation seems to be generally restored by the mid-2010s. The effect of output growth on output volatility is insignificant for all countries except for Italy and the US, for which the estimates are positive and statistically significant. Our estimates also show that output volatility is counter-cyclical for all countries.