Uncertainty shocks, banking frictions and economic activity

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Keywords: Uncertainty Shocks, Financial frictions, Stochastic Volatility, Perturbation Methods, Third-order approximation. JEL classification: E32, E52. Terms of use: Documents in Uncertainty, banking frictions and economic activityNon-technical summaryThe negative effect of uncertainty on economic activity is a prevalent topic in both economic policy and academic research. Policy makers and economists have repeatedly claimed that high macroeconomic uncertainty among investors hinders the economy to recover. While there has been a vastly growing literature on the macroeconomic effects of uncertainty shocks, led by the seminal paper by Bloom (2009), there has been relatively little research on the effects of uncertainty shocks under financial frictions. In this paper we contribute to fill this gap and provide an explanation under which conditions uncertainty shocks have a significant impact on economic dynamics. We do this by estimating a small Bayesian Vector Autoregressive (BVAR) model and show that higher uncertainty reduces main macroeconomic aggregates in the euro area. Then we show how this finding can be replicated within a theoretical framework, namely in a Dynamic Stochastic General Equilibrium (DSGE) model. Finally, we reconcile the stronger effects of uncertainty shocks found in the data, compared with the relatively little ones obtained with our DSGE model. We explain that there could be strong nonlinear effects due to the financial crisis and show that in a recession the impact of uncertainty shocks is potentially much larger.The strongest effect of a one-standard deviation increase in uncertainty hits after 4 quarters in our empirical model for the euro area. While the median response of GDP is a decline of about 0.2 percent, investment drops by about 0.5 percent. The results are in line with other empirical studies about the effects of uncertainty for other countries. As a bottom line, our results indicate that uncertainty shocks have negative business cycle effects in the euro area. Decomposing the volatility in changes in the GDP growth series reinforces the finding that uncertainty shocks are an important driver of economic activity. Almost 25 percent of total variation in GDP growth can be attributed to changes in the VSTOXX. Against this background, a further investigation of the theoretical propagators for uncertainty shocks is highly desirable to shed light on the main transmission channels of uncertainty shock to the real economy.Usi...

Are uncertainty shocks aggregate demand shocks?

“…Among many others,Clarida et al (1999) estimates the smoothing parameter of the Taylor rule at 0.79,Smets and Wouters (2003) at 0,95,Smets and Wouters (2007) at 0,81,Benati and Surico (2008) at 0.81,Benati and Surico (2009) at 0.74,Justiniano et al (2010) at 0,82.2 Bonciani and van Roye, (2016) give a similar intuition.…”

Uncertainty and Monetary Policy in Good and Bad Times

“…Leduc and Liu (2013) get similar results in a model with sticky prices and search frictions in the labor market. Bonciani and van Roye (2013) investigate the role played by frictions in the banking sector for the transmission of uncertainty shocks. Sticky retail interest rates due to monopolistic power enjoyed by Önancial intermediaries imply an imperfect pass-through of the central bank interest rate to the private sector.…”

“…Bloom, Floetotto, Jaimovich, Saporta-Eksten, and Terry (2012) show that resource reallocation among di §erently-productive Örms and consumption smoothing are likely to play a major role in the transmission of uncertainty shocks to the real economy. However, during economic downturns entrepreneurs and consumers are more likely to face harsher Önancial conditions, which can impede the implementation of optimal allocation plans by Örms and households (Canzoneri, Collard, Dellas, and Diba (2011), Bonciani and van Roye (2013)). Consequently, the economic e §ects of uncertainty shocks may very well be di §erent in good and bad times.…”

Realized EquiCorrelation: a bird’s-eye view of financial stress on equity markets

“…Economic theory suggests that increases in financial stress lead to changing behaviour of private sector investment and consumption. In addition, Bloom (2009), Baker et al (2012), and Bonciani and van Roye (2013) show that increasing uncertainty directly leads to economic contractions.…”