The Shape of Eurozone’s Uncertainty: Its Impact and Predictive Value on GDP

Abstract

This paper examines the role of uncertainty in the context of the business cycle in the euro area. To gain a more granular perspective on uncertainty, the paper decomposes uncertainty along two dimensions: First, we construct the four different moments of uncertainty, including the point estimate, the standard deviation, the skewness and the kurtosis. The second dimension of uncertainty spans along three distinct groups of economic agents, including consumers, corporates and financial markets. Based on this taxonomy, we construct uncertainty indices and assess the impact on real GDP via impulse response functions and further investigate their informational value in rolling out-of-sample GDP forecasts. The analysis lends evidence to the hypothesis that higher uncertainty expressed through the point estimate, a larger standard deviation among confidence estimates, positive skewness and a higher kurtosis are all negatively correlated with the business cycle. The impulse response functions reveal that in particular the first and the second moment of uncertainty cause a permanent effect on GDP with an initial decline and a subsequent overshoot. We find uncertainty in the corporate sector to be the main driver behind this observation, followed by financial markets’ uncertainty whose initial effect on GDP is comparable but receding much faster. While the first two moments of uncertainty improve GDP forecasts significantly, both the skewness and the kurtosis do not augment the forecast quality any further.