On the Identification of Financial and Uncertainty Shocks

There is a consensus about the increasing exposure to disruptions in the financial system and economic uncertainty over the recent years. Despite their different implications for policy, discriminating empirically between these two sources of economic fluctuations is not an easy task because their available empirical proxies are strongly correlated. We aim at making progress in discriminating financial and uncertainty shocks by means of an atheoretical approach to identification following the penalty function proposed by Uhlig (2003). We conclude that while the uncertainty channel plays a negligible role in the transmission of financial shocks; the financial channel is key in the transmission of uncertainty shocks. Financial shocks generate slowly-building and economically significant recessions followed by slow recoveries. Uncertainty shocks generate similar adverse effects if transmitted through the financial channel; otherwise, they have significantly smaller effects in economic activity.