Short‐ and long‐run price level uncertainty under different monetary policy regimes: an international comparison^†

The Impact of Short‐ and Long‐run Exchange Rate Uncertainty on Investment: A Panel Study of Industrial Countries*

“…Empirically, a differential impact from long‐ and short‐run uncertainty in prices on aggregate investment was emphasized by Chadha and Sarno (2002) 5 . They found evidence of a clear link between uncertainty in the price level and investment.…”

“…We sought to further refine the approach to investment and exchange rate uncertainty, adopting the insights of Chadha and Sarno (2002) by decomposing uncertainty into a permanent and transitory component. However, our approach uses the Engle and Lee (1999) technique to modelling GARCH, in contrast to the methods of Chadha and Sarno (2002) who utilise an unobserved components model and maximum likelihood estimation to identify the permanent and temporary aspects of price uncertainty. The authors also utilize their methods in terms of single‐equation estimation for each country, and we consider this question in a panel setting.…”

“…The authors use an unobserved components technique employing Kalman filtering and maximum likelihood estimation to separate permanent and transitory components of price uncertainty. Chadha and Sarno's (2002) study is a useful first empirical examination of this particular relationship between aggregate investment and uncertainty. But this evidence would, as suggested by the authors, benefit from further corroboration – which we consequently attempt to provide here.…”

Exchange rates and US direct investment into Latin America

“…Hence, there is an unambiguous result that a rise in volatility of the permanent component will boost profit volatility (firms act to take advantage of related permanent shifts in the exchange rate) while a rise in temporary volatility will dampen it (as firms become more conservative under heightened uncertainty). Finally, Chadha and Sarno (2002) empirically show differential impacts due to longand short-run uncertainty in prices on aggregate investment. Specifically, they find that short-run uncertainty in the price level is more important in determining real activity than long-run uncertainty.…”

“…Then again, the question often encountered is, how to proxy both the permanent and temporary measures of uncertainty? Chadha and Sarno (2002), among others, have used a Kalman filter to obtain both temporary and permanent components. Other papers rely on deviations or exchange rate misalignments from an estimated long-run equilibrium exchange rate.…”