Asymmetric effects of uncertainty shocks: Normal times and financial disruptions are different |
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Affiliation: | 1. Department of Economics, University of California, Berkeley USA;2. Economics Research and Regional Cooperation Department, Asian Development Bank;3. Department of Economics, Korea University, South Korea |
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Abstract: | We examine whether the response of the euro area economy to uncertainty shocks depends on financial conditions. We find strong evidence that uncertainty shocks have much more powerful effects on key macroeconomic variables in episodes marked by financial distress than in normal times. We also document that the recovery of economic activity following an adverse uncertainty shock is state dependent: it is gradual in normal times, but displays a more accelerated rebound when the shock hits during financial distress, reflecting monetary accommodation provided by the central bank. These findings are based on a non-linear data-driven model that accounts for regime switching and time-varying volatility. Our findings imply that whether financial markets are calm or distressed matters when it comes to the appropriate policy responses to uncertainty shocks. |
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Keywords: | Uncertainty Financial regime asymmetries Non-linear VAR Time-varying volatility |
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