Financial uncertainty and real activity: the good, the bad, and the ugly

Giovanni Caggiano, Efrem Castelnuovo, Silvia Delrio, Richard Kima

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Abstract

This paper quantifies the finance uncertainty multiplier (i.e., the magnifying effect of the real impact of uncertainty shocks due to credit frictions) by relying on two historical events related to the US economy, i.e., the large jump in financial uncertainty occurred in October 1987 (which was not accompanied by a deterioration of the credit supply conditions), and the comparable jump in financial uncertainty in September 2008 (which went hand-in-hand with an increase in financial stress). Working with a VAR framework and a set-identification strategy that focuses on - but it is not limited to - restrictions related to these two dates, we estimate the finance uncertainty multiplier to be around 2, i.e., credit supply disruptions are found to double the negative output response to an uncertainty shock. An exercise with employment as an indicator of the business cycle returns a finance uncertainty multiplier of about 1.5, i.e., lower but still sizeable.

Original languageEnglish
Article number103750
Number of pages14
JournalEuropean Economic Review
Volume136
DOIs
Publication statusPublished - Jul 2021

Keywords

  • Credit supply disruptions
  • Finance-uncertainty multiplier
  • Financial frictions
  • Set-identification
  • Uncertainty shocks
  • VAR

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