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Board of Governors of the Federal Reserve System (U.S.)
International Finance Discussion Papers
The Macroeconomic Impact of Financial and Uncertainty Shocks
Dario Caldara
Cristina Fuentes-Albero
Simon Gilchrist
Egon Zakrajsek
Abstract

The extraordinary events surrounding the Great Recession have cast a considerable doubt on the traditional sources of macroeconomic instability. In their place, economists have singled out financial and uncertainty shocks as potentially important drivers of economic fluctuations. Empirically distinguishing between these two types of shocks, however, is difficult because increases in economic uncertainty are strongly associated with a widening of credit spreads, an indication of a tightening in financial conditions. This paper uses the penalty function approach within the SVAR framework to examine the interaction between financial conditions and economic uncertainty and to trace out the impact of these two types of shocks on the economy. The results indicate that (1) financial shocks have a significant adverse effect on economic outcomes and that such shocks were an important source of cyclical fluctuations since the mid-1980; (2) uncertainty shocks, especially those implied by uncertainty proxies that do not rely on financial asset prices, are also an important source of macroeconomic disturbances; and (3) uncertainty shocks have an especially negative economic impact in situations where they elicit a concomitant tightening of financial conditions. Evidence suggests that the Great Recession was likely an acute manifestation of the toxic interaction between uncertainty and financial shocks.


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Dario Caldara & Cristina Fuentes-Albero & Simon Gilchrist & Egon Zakrajsek, The Macroeconomic Impact of Financial and Uncertainty Shocks, Board of Governors of the Federal Reserve System (U.S.), International Finance Discussion Papers 1166, May 2016.
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Keywords: Time-varying uncertainty ; Financial conditions ; Structural vector autoregression ; Optimization-based identification
DOI: 10.17016/IFDP.2016.1166
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