The Causality between Financial Instability and Monetary Policy Uncertainty: Who Predicts Whom?

Abstract

By employing the bootstrap full-sample Granger causality test and sub-sample rolling window causality test, this paper attempts to disentangle the causal nexus between financial instability and monetary policy uncertainty in the US, Japan, and Greece. The bootstrap full sample causality test reveals that there is unidirectional causality from monetary policy uncertainty to financial instability in the US, while there exists the reverse channel in Japan and Greece. Nonparametric Granger causality test further demonstrates that there is no causal relationship in each country, indicating the potential time-varying relationship between two variables. To allow the dynamic relationship between them, we use the bootstrap sub-sample rolling window Granger causality test and conclude that there are bidirectional causal relationships between financial instability and monetary policy uncertainty in specific subperiods for all three countries, such as during regional and global crisis. Overall, this paper helps us better understand the intricate mechanisms between financial instability and monetary policy uncertainty from the predictive perspective.