Output fluctuations and portfolio flows to emerging economies: The role of monetary uncertainty

Abstract

This paper examines the role of monetary-policy uncertainty (MPU) in driving business cycles in emerging economies. We employ a Bayesian vector autoregression model with stochastic volatility as the mean for different emerging economies. We find that MPU works as a crucial driver of business cycles in emerging economies. First, we show that an MPU shock can trigger instability in emerging economies by provoking risk/volatility in both financial and exchange-rate markets. Second, an MPU shock can lead to a decline in both output growth and capital inflows in emerging economies. Our empirical results suggest that the central banks of emerging economies should attempt to improve transparency in their monetary policy-making by increasing the effectiveness of public communication and forward guidance.