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Financial uncertainty and real activity: The good, the bad, and the ugly

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  • Caggiano, Giovanni
  • Castelnuovo, Efrem
  • Delrio, Silvia
  • Kima, Richard

Abstract

This paper quantifies the finance uncertainty multiplier (i.e., the magnifying effect of the real impact of uncertainty shocks due to credit frictions) by relying on two historical events related to the US economy, i.e., the large jump in financial uncertainty occurred in October 1987 (which was not accompanied by a deterioration of the credit supply conditions), and the comparable jump in financial uncertainty in September 2008 (which went hand-in-hand with an increase in financial stress). Working with a VAR framework and a set-identification strategy that focuses on - but it is not limited to - restrictions related to these two dates, we estimate the finance uncertainty multiplier to be around 2, i.e., credit supply disruptions are found to double the negative output response to an uncertainty shock. An exercise with employment as an indicator of the business cycle returns a finance uncertainty multiplier of about 1.5, i.e., lower but still sizeable.

Suggested Citation

  • Caggiano, Giovanni & Castelnuovo, Efrem & Delrio, Silvia & Kima, Richard, 2021. "Financial uncertainty and real activity: The good, the bad, and the ugly," European Economic Review, Elsevier, vol. 136(C).
  • Handle: RePEc:eee:eecrev:v:136:y:2021:i:c:s0014292121001033
    DOI: 10.1016/j.euroecorev.2021.103750
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    More about this item

    Keywords

    Uncertainty shocks; Finance-uncertainty multiplier; Set-identification; VAR; Credit supply disruptions; Financial frictions;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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