Uncertainty and Economic Activity: A Global Perspective

66 Pages Posted: 24 Mar 2014

See all articles by Ambrogio Cesa-Bianchi

Ambrogio Cesa-Bianchi

Bank of England

M. Hashem Pesaran

University of Southern California - Department of Economics; University of Cambridge - Trinity College (Cambridge)

Alessandro Rebucci

Johns Hopkins University - Carey Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

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Date Written: March 21, 2014

Abstract

The 2007-2008 global financial crisis and the subsequent anemic recovery have rekindled academic interest in quantifying the impact of uncertainty on macroeconomic dynamics based on the premise that uncertainty causes economic activity to slow down and contract. In this paper, we study the interrelation between financial markets volatility and economic activity assuming that both variables are driven by the same set of unobserved common factors. We further assume that these common factors affect volatility and economic activity with a time lag of at least a quarter. Under these assumptions, we show analytically that volatility is forward looking and that the output equation of a typical VAR estimated in the literature is mis-specified as least squares estimates of this equation are inconsistent. Empirically, we document a statistically significant and economically sizable impact of future output growth on current volatility, and no effect of volatility shocks on business cycles, over and above those driven by the common factors. We interpret this evidence as suggesting that volatility is a symptom rather than a cause of economic instability.

Keywords: Uncertainty, Realized volatility, GVAR, Great Recession, Identification, Business Cycle, Common Factors

JEL Classification: E44, F44, G15

Suggested Citation

Cesa-Bianchi, Ambrogio and Pesaran, M. Hashem and Rebucci, Alessandro, Uncertainty and Economic Activity: A Global Perspective (March 21, 2014). CAFE Research Paper No. 14.03. Available at SSRN: https://ssrn.com/abstract=2414003

Ambrogio Cesa-Bianchi

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

HOME PAGE: http://https://sites.google.com/site/ambropo/

M. Hashem Pesaran (Contact Author)

University of Southern California - Department of Economics

3620 South Vermont Ave. Kaprielian (KAP) Hall 300
Los Angeles, CA 90089
United States

University of Cambridge - Trinity College (Cambridge) ( email )

United Kingdom

Alessandro Rebucci

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

HOME PAGE: http://carey.jhu.edu/faculty-research/faculty-directory/alessandro-rebucci-phd

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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