The effect of nominal shock uncertainty on output growth

This paper tests some empirical implications of a theoretical model which proposes that the relationship between growth and its uncertainty depends fundamentally on whether the stochastic shocks causing fluctuations are real or nominal and on the presence of nominal rigidities in the economy. Shock uncertainty associated with cyclical variation is captured by a dynamic conditional variance model that estimates the time-varying, unpredictable volatility of nominal and real shocks and their effects on growth. In the context of a bivariate GARCH-in-Mean model we test the empirical conditional mean and variance relationships of nominal money and production growth rates in the G7 countries. We find that growth uncertainty has an insignificant effect but nominal money shock uncertainty exerts a negative and significant influence on growth for some of the G7. This is considered as supportive empirical evidence of the theoretical model predictions particularly on the link between nominal shock uncertainty and output growth. Another implication of the theoretical model that gains empirical support is that an increase in the average rate of money growth has a positive effect on the average output growth rate.