Abstract
This paper investigates if the impact of uncertainty shocks on the U.K. economy has changed over time. To this end, we propose an extended time-varying VAR model that simultaneously allows the estimation of a measure of uncertainty and its time-varying impact on key macroeconomic and financial variables. We find that the impact of uncertainty shocks on these variables has declined over time. The timing of the change coincides with the introduction of inflation targeting in the U.K.
Highlights
The recent financial crisis and ensuing recession have led to a renewed interest in the possible relationship between economic uncertainty and macroeconomic variables
We propose an extended TVP-VAR model that allows the estimation of a measure of uncertainty that encompasses volatility from the real and financial sectors of the economy and is a proxy for macroeconomic uncertainty
Uncertainty peaked in September 1981 following a stock market collapse in the U.K. and other industrial countries
Summary
The recent financial crisis and ensuing recession have led to a renewed interest in the possible relationship between economic uncertainty and macroeconomic variables. A number of papers use VAR-based analyses to estimate the impact of uncertainty shocks for the U.S and the U.K. (see, for example, [1] for the U.S and [2] for the U.K.) These studies report that uncertainty shocks have an adverse impact on the economy. The estimates reported in these papers are typically based on data that span the last three or four decades and, cover periods potentially characterised by changing dynamics, policy regimes and economic shocks. There has been limited focus on exploring whether the impact of uncertainty shocks has changed over time in the United Kingdom and identifying the factors that can possibly explain any temporal shifts.
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