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Measuring Uncertainty and Its Impact on the Economy

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  • Andrea Carriero
  • Todd E. Clark
  • Massimiliano Marcellino

Abstract

We propose a new framework for measuring uncertainty and its effects on the economy, based on a large VAR model with errors whose stochastic volatility is driven by two common unobservable factors, representing aggregate macroeconomic and financial uncertainty. The uncertainty measures can also influence the levels of the variables so that, contrary to most existing measures, ours reflect changes in both the conditional mean and volatility of the variables, and their impact on the economy can be assessed within the same framework. Moreover, identification of the uncertainty shocks is simplified with respect to standard VAR-based analysis, in line with the FAVAR approach and with heteroskedasticity-based identification. Finally, the model, which is also applicable in other contexts, is estimated with a new Bayesian algorithm, which is computationally efficient and allows for jointly modeling many variables, while previous VAR models with stochastic volatility could only handle a handful of variables. Empirically, we apply the method to estimate uncertainty and its effects using US data, finding that there is indeed substantial commonality in uncertainty, sizable effects of uncertainty on key macroeconomic and financial variables with responses in line with economic theory.

Suggested Citation

  • Andrea Carriero & Todd E. Clark & Massimiliano Marcellino, 2016. "Measuring Uncertainty and Its Impact on the Economy," BAFFI CAREFIN Working Papers 1639, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
  • Handle: RePEc:baf:cbafwp:cbafwp1639
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    More about this item

    Keywords

    Bayesian VARs; stochastic volatility; large datasets;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • C55 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Large Data Sets: Modeling and Analysis

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