Financial Stress and Economic Policy Uncertainty: Impulse Response Functions and Causality

Abstract:     
This study employs the vector autoregression (VAR) analysis to empirically report the impulse response functions of economic policy certainty and financial stress. A causality test of these two variables is also performed. The analysis of the monthly changes in the economic policy uncertainty index and the Federal Reserve Bank of St. Louis Financial Stress Index from 1994:1 to 2012:5 including up 9 lags shows that the financial stress jumps in the first, fifth, and eighth through twelfth months following economic policy shocks. In addition, economic policy uncertainty jumps in the first, third, fourth, sixth, seventh, and ninth months following financial stress shocks. The Granger causality test shows that financial stress and economic policy uncertainty Granger-cause each other. The time-series OLS regression analysis shows a statistically significant positive coefficient (b = 24.16609; t = 6.56) when monthly changes of financial stress is the independent variable.

Number of Pages in PDF File: 8

Keywords: policy uncertainty, financial stress, business cycle

JEL Classification: E32, E60, G20

Accepted Paper Series