Volatility and Growth

Prior research on the relationship between output volatility and growth has produced mixed results, lacking clear empirical evidence on the sign of the relationship. This paper investigates volatility-growth relationship from a different angle, with the conjecture that the sign of the volatility-growth relation changes across the business cycle phases. If the conjecture is right, then empirical investigations of data without taking this feature into account will fail to recover non-trivial relation between volatility and growth. We estimate a series of ARCH-type models with the real GDP data of the U.S. and the U.K., and find strong evidence suggesting that the volatility-growth relation is positive when the economy is in expansion, while higher volatility lowers growth rate in the contraction phase.