Uncertainty and Economic Activity: A Multi-Country Perspective

89 Pages Posted: 20 Feb 2018

See all articles by Ambrogio Cesa-Bianchi

Ambrogio Cesa-Bianchi

Bank of England

M. Hashem Pesaran

University of Southern California - Department of Economics

Alessandro Rebucci

Johns Hopkins University - Carey Business School; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); National University of Singapore (NUS) - Asian Bureau of Finance and Economic Research (ABFER)

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Date Written: February 2018

Abstract

Measures of economic uncertainty are countercyclical, but economic theory does not provide definite guidance on the direction of causation between uncertainty and the business cycle. This paper proposes a new multi-country approach to the analysis of the interaction between uncertainty and economic activity, without a priori restricting the direction of causality. We develop a multi-country version of the Lucas tree model with time-varying volatility and show that in addition to common technology shocks that affect output growth, higher-order moments of technology shocks are also required to explain the cross country variations of realized volatility. Using this theoretical insight, two common factors, a 'real' and a 'financial' one, are identified in the empirical analysis assuming different patterns of cross-country correlations of country-specific innovations to real GDP growth and realized stock market volatility. We then quantify the absolute and the relative importance of the common factor shocks as well as country-specific volatility and GDP growth shocks. The paper highlights three main empirical findings. First, it is shown that most of the unconditional correlation between volatility and growth can be accounted for by the real common factor, which is proportional to world growth in our empirical model and linked to the risk-free rate. Second, the share of volatility forecast error variance explained by the real common factor and by country-specific growth shocks amounts to less than 5 percent. Third, shocks to the common financial factor explain about 10 percent of the growth forecast error variance, but when such shocks occur, their negative impact on growth is large and persistent. In contrast, country-specific volatility shocks account for less than 1-2 percent of the growth forecast error variance.

Keywords: Business cycle, Common Factors, identification, Multi-Country, Real and Financial Global Shocks, uncertainty, Volatility.

JEL Classification: E44, F44, G15

Suggested Citation

Cesa-Bianchi, Ambrogio and Pesaran, M. Hashem and Rebucci, Alessandro, Uncertainty and Economic Activity: A Multi-Country Perspective (February 2018). CEPR Discussion Paper No. DP12713, Available at SSRN: https://ssrn.com/abstract=3126207

Ambrogio Cesa-Bianchi (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

HOME PAGE: http://https://sites.google.com/site/ambropo/

M. Hashem Pesaran

University of Southern California - Department of Economics ( email )

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Alessandro Rebucci

Johns Hopkins University - Carey Business School ( email )

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HOME PAGE: http://carey.jhu.edu/faculty-research/faculty-directory/alessandro-rebucci-phd

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National Bureau of Economic Research (NBER) ( email )

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National University of Singapore (NUS) - Asian Bureau of Finance and Economic Research (ABFER) ( email )

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