Measuring Uncertainty and Its Impact on the Economy

Abstract

We propose a new model for measuring uncertainty and its effects on the economy, based on a large vector autoregression with stochastic volatility driven by common factors representing macroeconomic and fi nancial uncertainty. The uncertainty measures refl ect changes in both the conditional mean and volatility of the variables, and their impact on the economy can be assessed within the same framework. Estimates with U.S. data show substantial commonality in uncertainty, with sizable effects of uncertainty on key macroeconomic and fi nancial variables. However, historical decompositions show a limited role of uncertainty shocks in macroeconomic fl uctuations.

Tax shocks with high and low uncertainty

“…The first is by Carriero, Clark, and Marcellino () and the second is by Rossi and Sekhposyan (). Also, we check the Economic Policy Uncertainty Index by Baker et al () and, as to financial uncertainty, we focus on that obtained by Ludvigson et al (), on the one by Carriero et al (), and on the VXO, a measure of financial market volatility based on options. For all these variables, we compute information criteria (BIC and AIC), using, for sake of comparability, a specification excluding the uncertainty measure itself as an endogenous variable.…”

“…The debate on the effects of fiscal policy has been revamped by the financial crisis and subsequent global recession, with a number of papers suggesting that the size of fiscal multipliers can be dependent on economic conditions Auerbach and Gorodnichenko (), Ramey and Zubairy (), Alesina et al (). The recession has also stimulated interest in the study of uncertainty, which is increasingly looked at as a fundamental factor in shaping economic agents' behavior, with an increasing body of literature trying to estimate the impact of uncertainty shocks on the economy (Alessandri & Mumtaz, ; Bachmann, Elstner, & Sims, ; Bachmann & Moscarini, ; Bloom, ; Bloom, Floetotto, Jaimovich, Saporta‐Eksten, & Terry, ; Carriero, Clark, & Marcellino, ; Gilchrist, Sim, & Zakrajsek, ; Jones & Enders, ; Ludvigson, Ma, & Ng, ), as well as to theoretically explain why changes in uncertainty may be a driver of the business cycle. Our work also tries to map into an aggregate approach the recent micro‐based empirical work by Benzarti and Carloni () on asymmetric response of agents to VAT changes of different sign and to theoretical work in behavioral economics by e.g.…”

“…We also explore other aggregate macroeconomic uncertainty measures that are conceptually affine, e.g. the one by Rossi and Sekhposyan () based on the Survey of Professional Forecasters or the one by Carriero, Clark, and Marcellino (, CCM), who estimate in a single model (a large Bayesian VAR with common and idiosyncratic volatilities) both macro and financial uncertainty measures. Also, we investigate measures of financial uncertainty: the one by Ludvigson, Ma, and Ng (, LMN), who extend JLN to allow also for financial uncertainty and possible endogeneity of uncertainty with respect to the business cycle, the one by CCM, and the VXO.…”

Measuring Global Macroeconomic Uncertainty and Cross-Country Uncertainty Spillovers

“…Berger et al (2016Berger et al ( , 2017, Mumtaz and Theodoridis (2017) and Mumtaz and Musso (2019) use multi-country factor models with stochastic volatility to decompose uncertainty in OECD countries into common and country-specific components. Based on U.S. data, Carriero et al (2017) jointly estimate uncertainty and its impact on the economy through a large VAR in which stochastic volatility is driven by common factors. Carriero et al (2020), Crespo Cuaresma et al (2019 and Pfarrhofer (2022) use large Bayesian VARs with common factors of volatility to measure uncertainty and its effects in advanced economies.…”

“…Since parameter uncertainty undermines individuals' confidence in the estimated probability distributions of economic outcomes, our measure is conceptually closer to Knightian or radical uncertainty than to risk (see, e.g., Rossi et al 2018;Epstein and Wang 1994;Drechsler 2013). Conversely, most of the existing econometric measures of uncertainty are based on the estimated volatility of shocks, implicitly treating probability distributions as certain and, thus, pertaining more to the concept of risk (see, however, Carriero et al 2017;Orlik and Veldkamp 2014;Benati 2008 for other approaches accounting for parameter uncertainty). The economic literature has emphasized the key role of parameter uncertainty in several contexts.…”