Uncertainty, Financial Markets, and Monetary Policy over the Last Century

Abstract

What has been the effect of uncertainty shocks in the U.S. economy over the last century? What are the historical roles of the financial channel and monetary policy channel in propagating uncertainty shocks? Our empirical strategies enable us to distinguish between the effects of uncertainty shocks on key macroeconomic and financial variables transmitted through each channel. A hundred years of data further allow us to answer these questions from a novel historical perspective. This paper finds robust evidence that financial conditions have played a crucial role in propagating uncertainty shocks over the last century, supporting many theoretical and empirical studies emphasizing the role of financial frictions in understanding uncertainty shocks. However, heightened uncertainty does not amplify the adverse effect of financial shocks, suggesting an asymmetric interaction between uncertainty and financial shocks. Interestingly, the stance of monetary policy seems to play only a minor role in propagating uncertainty shocks, which is in sharp contrast to the recent claim that binding zero-lower-bound amplifies the negative effect of uncertainty shocks. We argue that the contribution of constrained monetary policy to amplifying uncertainty shocks is largely masked by the joint concurrence of binding zero-lower-bound and tightened financial conditions.

Uncertainty before and during COVID‐19: A survey

“…They find that productivity growth falls more in industries that depend heavily on external finance. Choi and Yoon ( 2019 ) model a century of US data and show that, when the response of the BAA–AAA financial spread to an EPU shock is shut down, the negative output effects triggered by such shocks are milder. A similar result is found by Bordo et al.…”