Financial Disruptions and Heightened Uncertainty: A Case for Timely Policy Action

33 Pages Posted: 29 Jun 2020

See all articles by Valeriu Nalban

Valeriu Nalban

International Monetary Fund (IMF)

Andra Smadu

De Nederlandsche Bank - Research Department

Date Written: June 11, 2020

Abstract

We examine whether the response of the euro area economy to uncertainty shocks depends on the state of financial conditions. We find strong evidence that uncertainty shocks have much more powerful effects on key macroeconomic variables in episodes marked by financial distress than in normal times. We document that the recovery of economic activity is state-dependent following an adverse uncertainty shock. More precisely, it is gradual in normal times, but displays a more accelerated rebound when the shock hits during financial distress. These findings are based on a non-linear data-driven model that accounts for regime switching and time-varying volatility. Finally, from a policy perspective, we argue that whether financial markets are calm or distressed matters when it comes to the appropriate policy responses to uncertainty shocks.

Keywords: Uncertainty, financial regime asymmetries, non-linear VAR, time-varying volatility

JEL Classification: C32, E32, E44, E52

Suggested Citation

Nalban, Valeriu and Smadu, Andra, Financial Disruptions and Heightened Uncertainty: A Case for Timely Policy Action (June 11, 2020). De Nederlandsche Bank Working Paper No. 687, Available at SSRN: https://ssrn.com/abstract=3633859 or http://dx.doi.org/10.2139/ssrn.3633859

Valeriu Nalban (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Andra Smadu

De Nederlandsche Bank - Research Department ( email )

P.O. Box 98
1000 AB Amsterdam
Netherlands

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