Financial Distress and the Transmission of Macroeconomic Uncertainty: International Evidence

Abstract

We examine the effect of global macroeconomic uncertainty on economic activity, with the magnitude of the impact depending on the current state of the banking sector. Previous literature suggests that uncertainty and financial shocks are important drivers of economic activity, but the distinction between the two is empirically challenging. In this paper, we introduce a new measure of uncertainty that explicitly focuses on macroeconomic uncertaintyon an international level. Using this measure we study how the effects of global macroeconomic uncertainty interact with the state of the banking sector. While uncertainty generally does have an adverse impact on economic growth in a sample of advanced economies, the magnitude of the effect strongly depends on the current state of the banking sector, i.e. the uncertainty shock is strongly reinforced when financial intermediation is distressed. Our findings have important implications for policy-makers, suggesting that certainty about future policies is particularly important in the context of a financial crisis, as uncertainty shocks are approximately three times more harmful in such a macroeconomic environment.

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