Uncertainty and Economic Activity: A Multi-Country Perspective

85 Pages Posted: 5 Jun 2018

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)

Multiple version iconThere are 7 versions of this paper

Date Written: June 1, 2018

Abstract

Measures of economic uncertainty are countercyclical, but economic theory does not provide definite guidance on the direction of causation between uncertainty and the business cycle. This paper takes a common-factor approach to the analysis of the interaction between uncertainty and economic activity in a multi-country model without a priori restricting the direction of causality at the level of individual countries. Motivated by the observation that cross-country correlations of volatility series are much higher than cross-country correlations of GDP growth series, we set up a multi-country version of the Lucas tree model with time-varying volatility consistent with this stylized fact and use it to identify two common factors, a real and a financial one. We then quantify the absolute and the relative importance of the common shocks as well as country-specific volatility and GDP growth shocks. The paper highlights three main empirical findings. First, it is shown that most of the unconditional correlation between volatility and growth can be accounted for by shocks to the real common factor, which is extracted from world growth in our empirical model and linked to the risk-free rate in the theoretical model and in the data. Second, the share of volatility forecast error variance explained by the real common shock and by country-specific growth shocks amounts to less than 5%. Third, common financial shocks explain about 10% of the growth forecast error variance, but when such shocks occur, their negative impact on growth is large and persistent. In contrast, country-specific volatility shocks account for less than 1%-2% of the forecast error variance decomposition of country-specific growth rates.

Keywords: Uncertainty, business cycle, common factors, real and financial global shocks, multi-country,

JEL Classification: E44, F44, G15

Suggested Citation

Cesa-Bianchi, Ambrogio and Pesaran, M. Hashem and Rebucci, Alessandro, Uncertainty and Economic Activity: A Multi-Country Perspective (June 1, 2018). Bank of England Working Paper No. 730. Available at SSRN: https://ssrn.com/abstract=3191123 or http://dx.doi.org/10.2139/ssrn.3191123

Ambrogio Cesa-Bianchi (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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

M. Hashem Pesaran

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

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
10
Abstract Views
229
PlumX Metrics