The Time-Varying Correlation Between Macroeconomic Uncertainty, Inflation and Output Growth: Evidence from AR(p)-EGARCH Model for Sri Lanka
The Time-Varying Correlation Between Macroeconomic Uncertainty, Inflation and Output Growth: Evidence from AR(p)-EGARCH Model for Sri Lanka

Summary/Abstract: This study utilizes an AR(p)-EGARCH model to examine the causal links and volatility transmissions between inflation uncertainty, output growth uncertainty and macroeconomic performance measured by inflation and output growth in Sri Lanka for the period 1993-2014. The empirical results show that higher inflation does cause welfare loss, both directly and indirectly, through the inflation uncertainty channel. Thus, there is an overwhelming support for Friedman- Ball hypothesis that higher inflation is accelerating inflation uncertainty. Secondly, inflation is negatively affecting output growth (and its uncertainty) while inflation uncertainty is increasing output growth. Finally, output growth generates output uncertainty while there is no evidence of the mutual effects of nominal and real uncertainties on one another. Our estimated results suggest that policy makers should make use of monetary policy for achieving multiple policy objectives such as reducing inflation and its volatility while restoring sustained and stable economic growth.

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