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Financial disruptions and heightened uncertainty: a case for timely policy action

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  • Valeriu Nalban
  • Andra Smadu

Abstract

We examine whether the response of the euro area economy to uncertainty shocks depends on the state of 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 document that the recovery of economic activity is state-dependent following an adverse uncertainty shock. More precisely, it is gradual in normal times, but displays a more accelerated rebound when the shock hits during financial distress. These findings are based on a non-linear data-driven model that accounts for regime switching and time-varying volatility. Finally, from a policy perspective, we argue that whether financial markets are calm or distressed matters when it comes to the appropriate policy responses to uncertainty shocks.Â

Suggested Citation

  • Valeriu Nalban & Andra Smadu, 2020. "Financial disruptions and heightened uncertainty: a case for timely policy action," Working Papers 687, DNB.
  • Handle: RePEc:dnb:dnbwpp:687
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    References listed on IDEAS

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    Cited by:

    1. PINSHI, Christian P., 2023. "Claims, Deposits and Financial Conditions in DR Congo: Impact of COVID-19 on the Financial System," MPRA Paper 117381, University Library of Munich, Germany.
    2. MALATA, Alain K. & PINSHI, Christian P., 2020. "Système financier et COVID-19 : Un examen de l’impact en RDC [Financial system and COVID-19: A review of the impact in the DRC]," MPRA Paper 107772, University Library of Munich, Germany.

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    Keywords

    JEL codes: Working paper no.;

    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
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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