Financial uncertainty and real activity: The good, the bad, and the ugly

Giovanni Caggiano, Efrem Castelnuovo, Richard Kima and Silvia Delrio

CAMA Working Papers from Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University

Abstract: This paper quantifies the finance uncertainty multiplier (i.e., the magnifying effect of the real impact of uncertainty shocks due to financial frictions) by relying on two historical events related to the US economy, i.e., the large jump in financial uncertainty occurred in October 1987 (which was not accompanied by a deterioration of the credit supply conditions), and the comparable jump in financial uncertainty in September 2008 (which went hand-in-hand with an increase in financial stress). Working with a VAR framework and a set-identification strategy which focuses on - but it is not limited to - restrictions related to these two dates, we estimate the finance uncertainty multiplier to be equal to 2, i.e., credit supply disruptions are found to double the negative output response to an uncertainty shock. We then employ our model to estimate the overall economic cost of the COVID-19-induced uncertainty shock under different scenarios. Our results point to the possibility of a cumulative yearly loss of industrial production as large as 31% if credit supply gets disrupted. Liquidity interventions that keep credit conditions as healthy as they were before the COVID-19 uncertainty shock are found to substantially reduce such loss.

Keywords: Uncertainty shocks; finance-uncertainty multiplier; set-identification; VAR; financial frictions; COVID-19 (search for similar items in EconPapers)
JEL-codes: C32 E32 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2020-07
New Economics Papers: this item is included in nep-fdg and nep-mac
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Citations: View citations in EconPapers (6)

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Related works:
Journal Article: Financial uncertainty and real activity: The good, the bad, and the ugly (2021)
Working Paper: Financial Uncertainty and Real Activity: The Good, the Bad, and the Ugly (2020)
Working Paper: Financial Uncertainty and Real Activity: The Good, the Bad, and the Ugly (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:een:camaaa:2020-67

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