Does Uncertainty Reduce Growth? Using Disasters as Natural Experiments

Abstract

A growing body of evidence suggests that uncertainty is counter cyclical, rising sharply in recessions and falling in booms. But what is the causal relationship between uncertainty and growth? To identify this we construct cross country panel data on stock market levels and volatility as proxies for the first and second moments of business conditions. We then use natural disasters, terrorist attacks and unexpected political shocks as instruments for our stock market proxies of first and second moment shocks. We find that both the first and second moments are highly significant in explaining GDP growth, with second moment shocks accounting for at least a half of the variation in growth. Variations in higher moments of stock market returns appear to have little impact on growth.

Aggregate Uncertainty and Sectoral Productivity Growth: The Role of Credit Constraints

“…Finally, the results are robust to using economic policy uncertainty, which is less subject to reverse causality, and to IV approaches in the same vein of Baker and Bloom (2013).…”

“…This has motivated the use of structural models or of instrumental variables (IV) and 'natural experiment' approaches. For instance, Baker and Bloom (2013) use natural disasters and Durnev (2012), Julio and Yook (2012), and Gulen and Ion (2016) use elections as instruments for uncertainty. The use of industry-level data from a large number of countries over a reasonably long period of time offers another promising approach.…”

Uncertainty and Economic Activity: A Multi-Country Perspective

“…From an empirical perspective, as noted in the introduction, realized equity price volatility and output growth share a large and negative contemporaneous correlation at the country level, for most countries in our sample. This correlation is a robust stylized fact of the data documented also by Baker and Bloom (2013), Carriere-Swallow and Cespedes (2013), and Nakamura et al (2017). From a theoretical perspective, as shown in the previous section, one can think of f t as a common world growth factor (e.g., technology), which affects all countries GDP growth rates and equity price volatilities contemporaneously, which we will call 'real' factor in the rest of the paper.…”

“…Baker and Bloom (2013) study an unbalanced panel of 60 countries, documenting the counter-cyclicality of different proxies for uncertainty, such as stock market volatility, sovereign bond yields volatility, exchange rate volatility and GDP forecast disagreement, and use measures of disaster risk as instruments. Hirata et al (2012) estimate a factor-augmented VAR (FAVAR), with factors computed based on data for 18 advanced economies, and use a recursive identification scheme in which the volatility variable is ordered first in the VAR.…”

What Drives Business Cycle Fluctuations: Aggregate or Idiosyncratic Uncertainty Shocks?

“…The total number of firms increases from 3256 to 5567 over this period, with the coverage peaking at 9837 in 1999. 7 We replicate the methodology (with some modifications) of CLMX (2001) to estimate the volatility series 2 and 2 (see their paper for a more detailed description). Excess returns are defined as the spread over the 30 day Treasury bill rate (computed at the equivalent daily rate).…”