Uncertainty Shocks, Financial Frictions and Business Cycle Asymmetries Across Countries

Abstract

I show that uncertainty shocks trigger sharper declines in consumption and investment -- and a sharper increase in trade balances -- in emerging countries relative to advanced countries during recessions.  Using an open-economy model – estimated on a set of advanced and emerging countries – I demonstrate that these stylized facts can be explained by a novel nonlinear  interaction between uncertainty and financial frictions.  In particular, the results imply that during recessions elevated borrowing costs in emerging countries -- about 5.5% greater than advanced countries -- interact nonlinearly with uncertainty to generate the observed excess volatility.

Keywords: Advanced and Emerging Countries, Business Cycle Asymmetries, Financial Frictions, Recessions, Uncertainty Shocks