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Assessing the impact of uncertainty on consumption and investment

Author

Listed:
  • Narcissa Balta
  • Ismael Valdes Fernandez
  • Eric Ruscher

Abstract

Economic theory suggests that uncertainty has a detrimental effect on economic activity by giving agents the incentive to postpone investment, consumption and employment decisions until uncertainty is resolved, and by pushing up the cost of capital through increased risk premia. To test the impact of uncertainty on activity in the euro area, indicators of uncertainty for industry and consumers are derived from business and consumer surveys (BCS). The indicators measure the divergence of business and consumer expectations about the economy and their finances. The underlying assumption is that the more economic agents disagree in their expectations, the higher the uncertainty in the economy. The impact of uncertainty is then estimated using fully specified investment and consumption models. To benchmark the results of the estimation against alternative measures of uncertainty, the BCS indicators are compared with a widely used indicator of Policy Uncertainty. A key finding of the analysis is that uncertainty has a significant negative impact on both investment and consumption. The effect of uncertainty on economic activity also appears to have increased since the crisis. The econometric analysis indicates that uncertainty is currently hindering economic activity in the euro area. Although uncertainty in financial markets has abated significantly in recent months on the back of decisive policy interventions, other sources of macroeconomic uncertainty remain high. The policy uncertainty and BCS indicators are still unusually high and have so far shown only limited signs of improvement.

Suggested Citation

  • Narcissa Balta & Ismael Valdes Fernandez & Eric Ruscher, 2013. "Assessing the impact of uncertainty on consumption and investment," Quarterly Report on the Euro Area (QREA), Directorate General Economic and Financial Affairs (DG ECFIN), European Commission, vol. 12(2), pages 7-16, June.
  • Handle: RePEc:euf:qreuro:0122-01
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    File URL: http://ec.europa.eu/economy_finance/publications/qr_euro_area/2013/pdf/qrea2_focus_1_en.pdf
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    References listed on IDEAS

    as
    1. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July.
    2. Jorgenson, Dale W, 1971. "Econometric Studies of Investment Behavior: A Survey," Journal of Economic Literature, American Economic Association, vol. 9(4), pages 1111-1147, December.
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    Cited by:

    1. Peter Claeys & Borek Vasicek, 2017. "Transmission of Uncertainty Shocks: Learning from Heterogeneous Responses on a Panel of EU Countries," Working Papers 2017/13, Czech National Bank, Research Department.
    2. repec:eee:intfor:v:34:y:2018:i:2:p:355-365 is not listed on IDEAS

    More about this item

    Keywords

    economic uncertainty; consumption; investment;

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