Regime-Dependent Effects of Uncertainty Shocks: A Structural Interpretation

39 Pages Posted: 19 Mar 2019

Date Written: March 1, 2019

Abstract

Using a Markov-switching VAR, we show that the effects of uncertainty shocks on output are four times higher in a regime of economic distress than in a tranquil regime. We then provide a structural interpretation of these facts. To do so, we develop a business cycle model, in which agents are aware of the possibility of regime changes when forming expectations. The model is estimated using a Bayesian minimum distance estimator that minimizes, over the set of structural parameters, the distance between the regime-switching VAR-based impulse response functions and those implied by the model. Our results point to changes in the degree of financial frictions. We discuss the implications of this structural interpretation and show that the expectation effect of regime switching in financial conditions is an important component of the financial accelerator mechanism. If agents hold pessimistic expectations about future financial conditions, then shocks are amplified and transmitted more rapidly to the economy.

Keywords: Uncertainty shocks, Regime switching, Financial frictions, Expectation effects

JEL Classification: C32; E32; E44

Suggested Citation

Lhuissier, Stéphane and Tripier, Fabien, Regime-Dependent Effects of Uncertainty Shocks: A Structural Interpretation (March 1, 2019). Banque de France Working Paper, March 2019, WP #714 , Available at SSRN: https://ssrn.com/abstract=3354571 or http://dx.doi.org/10.2139/ssrn.3354571

Stéphane Lhuissier (Contact Author)

Banque de France ( email )

Paris
France

Fabien Tripier

University of Lille I

104, avenue du peuple Belge
Villeneuve d'Ascq Cedex, 59655
France

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