Policy Forum: Uncertainty and the Business Cycle - Some New Findings Introduction
Source TitleThe Australian Economic Review
University of Melbourne Author/sCastelnuovo, Efrem
Document TypeJournal Article
CitationsCastelnuovo, E. (2019). Policy Forum: Uncertainty and the Business Cycle - Some New Findings Introduction. The Australian Economic Review, 52 (3), pp.321-322. https://doi.org/10.1111/1467-8462.12344.
Access StatusOpen Access
Uncertainty has been a pretty hot topic among academics and economists working in policy circles since the global financial crisis. I believe we now know a lot more about its effects on the business cycles of a variety of countries than we knew before the crisis. Uncertainty tends to be recessionary, it exerts stronger effects when the economy is already experiencing difficulties from an aggregate standpoint, or when financial markets operate less smoothly, and it tends to harm macroeconomic policies’ effectiveness. In spite of the impressive amount of knowledge accumulated so far, gaps in the literature are still present. First, we do not know much about how long term rates respond to uncertainty shocks. While dynamic stochastic general equilibrium models approximated at third order offer predictions on how the term structure responds to uncertainty shocks, the literature has not yet produced many model‐free reduced‐form types of regressions on the link between uncertainty and long rates. This is a big hole, given the relevance of long rates on consumption and investment decisions. Second, we need to sharpen our understanding of monetary policy risk management. Uncertainty is clearly relevant from a policy standpoint. But do policymakers systematically monitor uncertainty? Moreover, do they disagree on the economic outlook, and if so, does this influence their decisions? Third, we need proxies for uncertainty for a broader set of countries than the G7. For example, how does uncertainty evolve in a country like New Zealand as opposed to, say, the United States? This special issue addresses all these questions. The first paper, ‘Yield curve and financial uncertainty: Evidence based on US data’, estimates the response of the US yield curve to a jump in financial uncertainty. I address this question by conducting a local projection analysis with US monthly data from 1962–2018. I find both ends of the yield curve respond negatively and significantly. The response of the short end of the yield curve is stronger than that of the long end, that is, a financial uncertainty shock causes a temporary steepening of the yield curve. This result is consistent, among other interpretations, with medium‐term expectations of a recovery in real activity after a financial uncertainty shock.
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