Assessing International Commonality in Macroeconomic Uncertainty and its Effects

Abstract

This paper uses a large vector autoregression (VAR) to measure international macroeconomic uncertainty and its effects on major economies, using two datasets, one with GDP growth rates for 19 industrialized countries and the other with a larger set of macroeconomic indicators for the U.S., euro area, and U.K. Using basic factor model diagnostics, we fi rst provide evidence of signifi cant commonality in international macroeconomic volatility, with one common factor accounting for strong comovement across economies and variables. We then turn to measuring uncertainty and its effects with a large VAR in which the error volatilities evolve over time according to a factor structure. The volatility of each variable in the system refl ects time-varying common (global) components and idiosyncratic components. In this model, global uncertainty is allowed to contemporaneously affect the macroeconomies of the included nations-both the levels and volatilities of the included variables. In this setup, uncertainty and its effects are estimated in a single step within the same model. Our estimates yield new measures of international macroeconomic uncertainty, and indicate that uncertainty shocks (surprise increases) lower GDP and many of its components, adversely affect labor market conditions, lower stock prices, and in some economies lead to an easing of monetary policy.

Endogenous Uncertainty

“…Note that the parameters of the conditional means in the reduced form are not time-varying, while the reduced-form equation for y t has time-varying conditional variance (and covariance), but such time variation is entirely driven by m t and h t . It follows that the solution for ( ; ; y ; m ; y ; m ; 2 u ) of the system in (17) is the same for any t. In order to …nd such a solution, …rst note that under knowledge of one can obtain ( y ; m ; y ; m ) using the …rst four equations of the system in (17). Similarly, under knowledge of one can obtain 2 u by using the last equation.…”

“…This speci…cation of variables is very similar to those considered in JLN and Bloom (2009), and contains many of the same variables in the VAR of Caldara, et al (2016). 17 We use four lags and estimate over the sample 1961m7 to 2016m11, for a total of T = 659 observations. As with the quarterly VAR, all variables are demeaned prior to estimation to reduce the computational burden.…”

“…To obtain the system for the bivariate case it is su¢ cient to set n = 1 and tr;t = p m t h t (a scalar). This implies 19 B = 1, and straightforward algebra leads to the system in (17).…”