Interest Sensitivity and Volatility Reductions: Cross-Section Evidence

25 Pages Posted: 26 Jul 2005

See all articles by Owen Irvine

Owen Irvine

Michigan State University - Department of Economics

Scott D. Schuh

Federal Reserve Bank of Boston - Research Department

Date Written: August 2004

Abstract

As has been widely observed, the volatility of GDP has declined since the mid-1980s compared with prior years. One leading explanation for this decline is that monetary policy improved significantly in the later period. We utilize a cross-section of 2-digit manufacturing and trade industries to further investigate this explanation. Since a major channel through which monetary policy operates is variation in the federal funds rate, we hypothesized that industries that are more interest sensitive should have experienced larger declines in the variance of their outputs in the post-1983 period. We estimate interest-sensitivity measures for each industry from a variety of VAR models and then run cross-sectional regressions explaining industry volatility ratios as a function of their interest-sensitivity measures. These regressions reveal little evidence of a statistically significant relationship between industry volatility reductions and our measures of industry interest sensitivity. This result poses challenges for the hypothesis that improved monetary policy explains the decline in GDP volatility.

JEL Classification: E22, E32, E50

Suggested Citation

Irvine, F. Owen and Schuh, Scott, Interest Sensitivity and Volatility Reductions: Cross-Section Evidence (August 2004). FRB of Boston Working Paper No. 05-4. Available at SSRN: https://ssrn.com/abstract=760244 or http://dx.doi.org/10.2139/ssrn.760244

F. Owen Irvine

Michigan State University - Department of Economics ( email )

Marshall Hall
East Lansing, MI 48823
United States
517-204-7589 (Phone)

Scott Schuh (Contact Author)

Federal Reserve Bank of Boston - Research Department ( email )

600 Atlantic Ave.
Boston, MA 02210
United States
617-973-3941 (Phone)
617-619-7541 (Fax)

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