The Inflation-Output Volatility Tradeoff and Exchange Rate Shocks in Mexico and Turkey

Abstract

Using a Standard Vector Autorregresion with Autocorrelated Time Varying Covariances this paper finds evidence of a vertical inflation-output volaiility tradeoff in Mexicp and Turkey. it is found, contrary to common economic wisdom, that there is no tradeoff betvveen output and inflation so that monetary policy affects only prices. In addition, it is observed that the exchange rate crucially affects the dynamics of prices, inflation and output. The pass-through from exchange rate to inflation is high and significant in both economies and periods of high exchange rate volatility are associated with unstable rates of inflation. Also, in agreement with many other studies, it is shovm here that nominal depreciations are contractionary