We estimate an Interacted-VAR model allowing for the impact of uncertainty shocks to depend on the average outlook of the economy measured by survey data. We …nd that, in response to the same uncertainty shock, industrial production and in ‡ation's peak decrease is around three and a half times larger during pessimistic times. We build scenarios for a path of innovations in uncertainty consistent with the COVID-19-induced shock. Industrial production is predicted to experience a year-over-year peak loss of between 15:1% and 19% peaking between September and December 2020, and subsequently to recover with a rebound to pre-crisis levels between May and August 2021. The large impact is the result of an extreme shock to uncertainty occurring at a time of very negative expectations on the economic outlook.

We evaluate the forecasting performance of time series models for the production side of gross domestic product (GDP)-that is, for the sectoral real value-added series summing up to aggregate output. We focus on two strategies to model a large number of interdependent time series simultaneously: a Bayesian vector autoregressive model (BVAR) and a factor model structure; and compare them to simple aggregate and disaggregate benchmarks. We evaluate point and density forecasts for aggregate GDP and the cross-sectional distribution of sectoral real value-added growth in the euro area and Switzerland.We find that the factor model structure outperforms the benchmarks in most tests, and in many cases also the BVAR. An analysis of the covariance matrix of the sectoral forecast errors suggests that the superiority can be traced back to the ability to capture sectoral comovement more accurately.

Policymakers face an extremely uncertain environment during COVID-19. Using a nonlinear VAR estimate for the Euro Area, we argue that the benefit of reducing policy uncertainty at a time dominated by pessimistic expectations amounts to several points of GDP. The impact on the economy of uncertainty shocks is much larger during periods of negative outlook for the future. We estimate the impact on industrial production of the current COVID-19 induced uncertainty to peak at a year-over-year growth loss of −15.4 per cent in September 2020, and to lead to a fall in CPI inflation between 1 per cent and 1.5 per cent. Policies providing state-contingent scenarios ready to be adopted if the worst-case outcomes materialise can reduce the impact of uncertainty.