Uncertainty shocks, financial frictions, and business cycle asymmetries across countries

Abstract

I show that uncertainty shocks trigger sharper declines in consumption, investment, and GDP – and a sharper increase in trade balances – in emerging countries relative to advanced countries during recessions. Using an open-economy model – estimated on a set of advanced and emerging countries – I demonstrate that these facts can be explained by an interaction between uncertainty and financial frictions. In particular, the results imply that during recessions, elevated borrowing costs in emerging countries – about 5.9% greater than advanced countries – interact nonlinearly with uncertainty to generate the observed excess volatility.