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Does Uncertainty Reduce Growth? Using Disasters as Natural Experiments

  • Scott R. Baker
  • Nicholas Bloom

A growing body of evidence suggests that uncertainty is counter cyclical, rising sharply in recessions and falling in booms. But what is the causal relationship between uncertainty and growth? To identify this we construct cross country panel data on stock market levels and volatility as proxies for the first and second moments of business conditions. We then use natural disasters, terrorist attacks and unexpected political shocks as instruments for our stock market proxies of first and second moment shocks. We find that both the first and second moments are highly significant in explaining GDP growth, with second moment shocks accounting for at least a half of the variation in growth. Variations in higher moments of stock market returns appear to have little impact on growth.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19475.

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Date of creation: Sep 2013
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Handle: RePEc:nbr:nberwo:19475
Note: DEV EFG LS ME PR
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