The Timing of Uncertainty Shocks in a Small Open Economy

Abstract

Foreign measures of uncertainty, such as the US EPU index, are often used as a proxies for domestic uncertainty in small open economies. We construct an EPU index for Sweden and demonstrate that shocks to the domestic index yield different impulse response functions for GDP growth than shocks to the US index. In particular, a one standard deviation shock to the Swedish index delivers its maximum impact in the same quarter, lowering GDP growth by 0.2 percentage points. In contrast, a shock to the US index delivers its maximum impact with a one-quarter delay. Other foreign proxies, such as the EU and German indices, also generate effects that peak with a one-quarter delay. (JEL D80, E66, F41, F42)

Economic policy uncertainty spillovers in Europe before and after the Eurozone crisis

“…Stockhammar and Österholm (2016) and Armelius et al. (2017) find evidence that US uncertainty shocks affect negatively Swedish GDP growth. Colombo (2013) examines the transmission of US uncertainty shocks to Europe, identifying a high impact on European GDP.…”

“…Despite the recent appearance of the EPU concept in the literature, empirical work on EPU has fast attracted the interest of researchers. However, to date, there has been a small number of papers dealing with uncertainty shock spillovers with the majority focusing on the transmission of US uncertainty shocks (Armelius et al., 2017; Caggiano et al., 2020; Colombo, 2013). Another part of the literature investigates the effects of US or European uncertainty shocks on the economies of other countries outside US and Europe (IMF, 2013).…”

Indicators of Uncertainty: A Brief User’s Guide

“…Also, results get worse once media coverage and/or the countries under consideration are smaller or simply not as central as the US. Two such examples are EPU indexes for Ireland and Sweden, respectively developed in Zalla (2017) and Armelius et al (2017), and hosted on Baker, Bloom and Davis' uncertainty website http://www.policyuncertainty. com.…”

Economic Policy Uncertainty and Stock Market Participation

“…In addition, we estimate a placebo regression in which we consider the EPU index calculated for Swedish newspapers (see Armelius et al 2017). While this index displays a correlation of almost .5 with its counterpart one for the US, it does not have any independent explanatory power when it is interacted with hours that US households spend in reading (presumably domestic) newspapers.…”