The Macroeconomic Impact of Financial and Uncertainty Shocks

44 Pages Posted: 27 May 2016

See all articles by Dario Caldara

Dario Caldara

Board of Governors of the Federal Reserve System

Cristina Fuentes-Albero

Federal Reserve Board; Rutgers University; Rutgers, The State University of New Jersey - Department of Economics

Simon Gilchrist

Boston University - Department of Economics; National Bureau of Economic Research (NBER)

Egon Zakrajsek

Federal Reserve Board - Division of Monetary Affairs

Multiple version iconThere are 2 versions of this paper

Date Written: 2016-05

Abstract

The extraordinary events surrounding the Great Recession have cast a considerable doubt on the traditional sources of macroeconomic instability. In their place, economists have singled out financial and uncertainty shocks as potentially important drivers of economic fluctuations. Empirically distinguishing between these two types of shocks, however, is difficult because increases in economic uncertainty are strongly associated with a widening of credit spreads, an indication of a tightening in financial conditions. This paper uses the penalty function approach within the SVAR framework to examine the interaction between financial conditions and economic uncertainty and to trace out the impact of these two types of shocks on the economy. The results indicate that (1) financial shocks have a significant adverse effect on economic outcomes and that such shocks were an important source of cyclical fluctuations since the mid-1980; (2) uncertainty shocks, especially those implied by uncertainty proxies that do not rely on financial asset prices, are also an important source of macroeconomic disturbances; and (3) uncertainty shocks have an especially negative economic impact in situations where they elicit a concomitant tightening of financial conditions. Evidence suggests that the Great Recession was likely an acute manifestation of the toxic interaction between uncertainty and financial shocks.

Keywords: Time-varying uncertainty, Financial conditions, Structural vector autoregression, Optimization-based identification

JEL Classification: E32, E37, E44

Suggested Citation

Caldara, Dario and Fuentes-Albero, Cristina and Gilchrist, Simon and Zakrajsek, Egon, The Macroeconomic Impact of Financial and Uncertainty Shocks (2016-05). FRB International Finance Discussion Paper No. 1166. Available at SSRN: https://ssrn.com/abstract=2785501 or http://dx.doi.org/10.17016/IFDP.2016.1166

Dario Caldara (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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Cristina Fuentes-Albero

Federal Reserve Board ( email )

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Rutgers, The State University of New Jersey - Department of Economics ( email )

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Simon Gilchrist

Boston University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Egon Zakrajsek

Federal Reserve Board - Division of Monetary Affairs ( email )

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Washington, DC 20551
United States
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202-452-3819 (Fax)

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