The impact of uncertainty shocks in emerging economies

Abstract

A recent strand of research proposes that sudden jumps in uncertainty generate rapid drops and recoveries in real macroeconomic variables that drive the business cycle. Using an empirical model, we find substantial heterogeneity in reactions to these shocks across countries. In comparison to the U.S. and other developed countries, emerging economies suffer much more severe falls in investment and private consumption following an exogenous uncertainty shock, take significantly longer to recover, and do not experience a subsequent overshoot in activity. We provide evidence that the dynamics of investment and consumption are correlated with the depth of financial markets. We control for the potential role of a credit channel, and estimate that it can account for up to one-half of the increased fall in investment generated by uncertainty shocks among emerging economies with less-developed financial markets. In this context, monetary and fiscal policy actions that alleviate the impact of credit constraints facing firms may reduce the impact of uncertainty shocks in these economies.