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International Effects of Euro Area versus US Policy Uncertainty: A FAVAR Approach

Ansgar Belke () and Thomas Osowski

No 201703, ROME Working Papers from ROME Network

Abstract: Building on the growing evidence on the importance of large data sets for empirical macroe-conomic modeling, we estimate a large-scale FAVAR model for 18 OECD member countries. We quantify the global effects of economic policy uncertainty shocks and check whether the signs, the magnitude, and the persistence profile are consistent with the literature on the real and financial sector effects of uncertainty. In that respect, we compare the impacts of a US and a Euro area uncertainty shock. According to our results, an increase in uncertainty has a strong negative impact on economic activity, consumer prices, equity prices and interest rates. Uncertainty shocks cause deeper recessions in Continental Europe (except Germany) than in Anglo-Saxon countries. This pattern is compatible with the view that continental Europe still suffers from institutions which prevent flexible markets. And US uncertainty shocks have a bigger impact than their European counterparts. Uncertainty does not only impact that country where the shock originates but also has large cross-border effects. In that respect, Switzerland turns out to be the most affected non-Euro area European country. We also find a high degree of synchronization among the responses of national variables to a (foreign) uncertainty shock, indicating evidence of an international business cycle. With respect to the responses of na-tional long-term interest rates to an uncertainty shock, our results reveal a strong “North-South” divide within EMU with rates decreasing less significantly in the South. Another im-portant result is that uncertainty shocks emerging in one region quickly raise uncertainty out-side the region of origin which appears to be an important transmission channel of uncertainty.

Keywords: Economic policy uncertainty; Europe; FAVAR analysis; large-scale econometric models; option value of waiting; uncertainty effects; international uncertainty spillovers; United States (search for similar items in EconPapers)
JEL-codes: C32 F42 D80 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-eec
Date: 2017-03
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http://www.rome-net.org/RePEc/rmn/wpaper/rome-wp-2017-03.pdf First version, 2017 (application/pdf)

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Working Paper: International Effects of Euro Area versus US Policy Uncertainty: A FAVAR Approach (2017) Downloads
Working Paper: International effects of euro area versus US policy uncertainty: A FAVAR approach (2017) Downloads
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