Financial regimes and uncertainty shocks

By Piergiorgio Alessandri, Haroon Mumtaz. Journal of Monetary Economics, 2019

249 citations recorded by the source corpus.

Financial markets are central to the transmission of uncertainty shocks. This paper documents a new aspect of the interaction between the two by showing that uncertainty shocks have radically different macroeconomic implications depending on the state financial markets are in when they occur. Using monthly US data, we estimate a nonlinear VAR where economic uncertainty is proxied by the (unobserved) volatility of the structural shocks, and a regime change occurs whenever credit conditions cross a critical threshold. An exogenous increase in uncertainty has recessionary effects in both good and bad credit regimes, but its impact on output is estimated to be five times larger when the economy is experiencing financial distress. Accounting for this nonlinearity, uncertainty accounts for about 1% of the peak fall in industrial production observed in the 2007-2009 recession.

Subfields: Economics and Econometrics

View Paper: https://www.semanticscholar.org/paper/dba866aaec624211e1f1ae99b435ffe47cd1c6b2

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Citations in the corpus

• Economic Policy Uncertainty Spillovers in Booms and Busts (2019, unknown): “(2019) measure of uncertainty, which focuses on financial indicators, is arguably more exogenous (for evidence in this sense, see Angelini et al., 2019 and Ludvigson et al., 2019). For the same reason indicated above, we model this measure after the US EPU index, whose shocks have already been shown”
• Measuring Uncertainty and Its Impact on the Economy (2016, unknown): “Defining the rescaled residuals ṽt = Avt, taking the log squares of (1), subtracting out the known (in the conditional posterior) contributions of the common factors, and using (3) yields the observation equations (c̄ denotes an offset constant used to avoid problems with near-zero values): { ln(ṽ2 ”
• Identifying Uncertainty Shocks Using the Price of Gold (2018, unknown): “Alessandri and Mumtaz (2014) identify uncertainty shocks in a VAR as the exogenous variations to a variable that scales the variance-covariance matrix of the structural shocks. Caldara et al. (2014) identify uncertainty and financial shocks as the ones that have the highest impact on the measure of ”
• Economic uncertainty and bank risk: Evidence from emerging economies (2020, background): “Alessandri and Mumtaz (2019) argue that the vulnerability of economy to increased uncertainty is conditional on the strength of financial institutions.”