International Transmission of Confidence Shocks

Abstract

This paper investigates the role of global confidence cycles, measured as the common factor across a wide range of business or consumer confidence indicators, on macroeconomic and financial fluctuations in 40 countries. I estimate a factor-augmented vector autoregression model, where global confidence shocks are identified through recursive restriction. I report two main results. First, the global confidence cycle has played a key role in macroeconomic fluctuations, explaining over a quarter of total variation in industrial production and unemployment rates over 1985-2019, based on median across countries. Second, the transmission of global confidence shocks to domestic variables was significant in most countries although it was more pronounced in advanced economies than in emerging market and developing economies.