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Uncertainty and Economic Activity: A Multi-Country Perspective

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  • Cesa-Bianchi, Ambrogio
  • Pesaran, M Hashem
  • Rebucci, Alessandro

Abstract

Measures of economic uncertainty are countercyclical, but economic theory does not provide definite guidance on the direction of causation between uncertainty and the business cycle. This paper proposes a new multi-country approach to the analysis of the interaction between uncertainty and economic activity, without a priori restricting the direction of causality. We develop a multi-country version of the Lucas tree model with time-varying volatility and show that in addition to common technology shocks that affect output growth, higher-order moments of technology shocks are also required to explain the cross country variations of realized volatility. Using this theoretical insight, two common factors, a `real' and a `financial' one, are identified in the empirical analysis assuming different patterns of cross-country correlations of country-specific innovations to real GDP growth and realized stock market volatility. We then quantify the absolute and the relative importance of the common factor shocks as well as country-specific volatility and GDP growth shocks. The paper highlights three main empirical findings. First, it is shown that most of the unconditional correlation between volatility and growth can be accounted for by the real common factor, which is proportional to world growth in our empirical model and linked to the risk-free rate. Second, the share of volatility forecast error variance explained by the real common factor and by country-specific growth shocks amounts to less than 5 percent. Third, shocks to the common financial factor explain about 10 percent of the growth forecast error variance, but when such shocks occur, their negative impact on growth is large and persistent. In contrast, country-specific volatility shocks account for less than 1-2 percent of the growth forecast error variance.

Suggested Citation

  • Cesa-Bianchi, Ambrogio & Pesaran, M Hashem & Rebucci, Alessandro, 2018. "Uncertainty and Economic Activity: A Multi-Country Perspective," CEPR Discussion Papers 12713, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:12713
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    References listed on IDEAS

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    Cited by:

    1. Chudik, Alexander & Pesaran, M. Hashem & Mohaddes, Kamiar, 2018. "Identifying Global and National Output and Fiscal Policy Shocks Using a GVAR," Globalization Institute Working Papers 351, Federal Reserve Bank of Dallas.
    2. Chudik, A. & Pesaran, H. & Mohaddes, K., 2018. "Identifying Global and National Output and Fiscal Policy Shocks Using a GVAR," Cambridge Working Papers in Economics 1874, Faculty of Economics, University of Cambridge.
    3. George Kapetanios & M. Hashem Pesaran & Simon Reese, 2018. "A Residual-based Threshold Method for Detection of Units that are Too Big to Fail in Large Factor Models," CESifo Working Paper Series 7401, CESifo Group Munich.
    4. Seohyun Lee & Rickard Nyman, 2019. "Tracking Uncertainty through the Relative Sentiment Shift Series," Working Papers 2019-12, Economic Research Institute, Bank of Korea.

    More about this item

    Keywords

    Business cycle; Common Factors; identification; Multi-Country; Real and Financial Global Shocks; uncertainty; volatility;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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