Financial regimes and uncertainty shocks

Abstract

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 di¤erent macroeconomic implications depending on the state …nancial 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 e¤ects in both good and bad credit regimes, but its impact on output is estimated to be …ve times larger when the economy is experiencing …nancial distress. Accounting for this nonlinearity, uncertainty accounts for about 1% of the peak fall in industrial production observed in

Uncertainty across volatility regimes

“…This can be due to large financial frictions, as in Alfaro et al (2018), Caggiano, Castelnuovo, Delrio, and Robinson (2017), and Gilchrist et al (2014), or to the presence of the zero lower bound, as in Caggiano, Castelnuovo, and Pellegrino (2017) and Basu and Bundick (2017). They also support theoretical and empirical research that highlights how uncertainty shocks might have time-varying effects that depend on different macroeconomic conditions, such as the level of financial frictions (Alessandri and Mumtaz, 2018;Alfaro et al, 2018;Gilchrist et al, 2014), the stance of the business cycle (Cacciatore & Ravenna, 2016;Caggiano et al, 2014), or the stance of monetary policy (Basu & Bundick, 2017;Caggiano, Castelnuovo, & Pellegrino, 2017).…”

“…The second issue requires moving away from linear SVARs, which would not allow to uncover possibly regime-dependent effects of uncertainty shocks. This concern has been addressed in the recent literature, and evidence that uncertainty shocks have time-varying effects has been provided by, among others, Alessandri and Mumtaz (2018), Caggiano, Castelnuovo, and Groshenny (2014), and Caggiano, Castelnuovo, and Pellegrino (2017). These early attempts of examining causality and time variation of uncertainty shocks have looked at the two issues in isolation.…”

Economic Policy Uncertainty Spillovers in Booms and Busts

“…Recent contributions, e.g. Caldara, Fuentes-Albero, Gilchrist, and Zakrajšek (2016) and Alessandri and Mumtaz (2014), show that the effects of uncertainty shocks are ampli…ed when …nancial stress is high. Gilchrist and Zakrajšek (2012) propose a micro-founded measure of excess bond premium (EBP).…”

Identifying Uncertainty Shocks Using the Price of Gold

“…Alessandri and Mumtaz (2014) identify uncertainty shocks in a VAR as the exogenous variations to the variance-covariance matrix of the structural shocks. Alessandri and Mumtaz (2014) identify uncertainty shocks in a VAR as the exogenous variations to the variance-covariance matrix of the structural shocks.…”

“…There are other papers proposing identification approaches for uncertainty shocks differing from the recursive one. Alessandri and Mumtaz (2014) identify uncertainty shocks in a VAR as the exogenous variations to the variance-covariance matrix of the structural shocks. Caldara et al (2016), instead, identify uncertainty and financial shocks as the ones that have the highest impact on the measure of uncertainty and on the financial variable in the VAR, respectively.…”