Monetary Volatility and Real Output Volatility : An Empirical Model of the Financial Transmission Mechanism in Australia

This paper examines how monetary volatility is transmitted to the volatility of financial asset prices, inflation and real output in an open economy. A Markowitz efficient portfolio is constructed to eliminate diversifiable financial risk, and estimation by GLS on monthly Australian data from 1972(1)-1994(1) using the general-to-specific estimation strategy overcomes the generated regressors problem in related ARCH-type models. The findings include: first, higher monetary volatility is associated with lower volatility of financial asset prices and higher real output volatility, and second, monetary volatility is transmitted to real output volatility predominantly through the share market with no foreign exchange market effect