Working Papers

Uncertainty shocks trigger sharper declines in consumption, investment, GDP and a stronger countercyclical response in trade-balances in emerging countries compared to advanced economies. I propose and estimate a nonlinear open-economy model with financial frictions to reconcile these stylized facts in a micro-founded environment. Estimating this nonlinear model using data for 8 countries I find that heightened uncertainty is common across advanced and emerging countries during recessions however higher financial frictions is key towards generating the observed excess volatility in emerging countries. I find borrowing costs to be 592 basis points higher in emerging countries during downturns vis-à-vis advanced economies.

Perceived Uncertainty Shocks, Excess Optimism-Pessimism, and Learning in the Business Cycle

with Fabio Milani, University of California, Irvine

Draft available on request

This paper studies the effects of uncertainty and waves of optimism and pessimism over the business cycle. We develop a behavioral New Keynesian macroeconomic model, in which we relax the assumption of rational expectations. The conventional New Keynesian model is extended to allow for a potential impact of uncertainty shocks on the real economy and for shifts in sentiment, i.e. changes in aggregate optimism or pessimism in the formation of expectations that are unjustified based on current and past fundamentals. We estimate the structural model using Bayesian methods and exploiting a variety of subjective expectation series at different horizons from the Survey of Professional Forecasters. We find changes in perceived uncertainty can generate significant changes in real activity and play an important role in belief formation. The results shed light on the overall importance of behavioral forces over the business cycles and on the relative contribution of first-moment, sentiment, shocks versus second-moment, perceived uncertainty, shocks.


Studies in Nonlinear Dynamics and Econometrics, 2018

Technical Appendix

In this paper, I investigate the impact of uncertainty shocks across countries in recessions by using a Smooth Transition Vector Auto Regression (STVAR) framework. I compare the responses of real variables in recessions as predicted by the STVAR model with the responses obtained from a linear SVAR model. The results emphasize asymmetries in two dimensions. First, using a sample of 8 countries, (U.S., U.K, France, Canada, Mexico, Chile, Argentina, and South Korea) I show that uncertainty shocks trigger deeper and more persistent effects on real variables in emerging countries in comparison to advanced countries during recessionary episodes. Second, I show that the linear SVAR model consistently underestimates the response of macroeconomic variables to uncertainty shocks when compared to the predictions of the recessionary regime of the STVAR model. Furthermore, using forecast error variance decomposition I show that innovations to aggregate macroeconomic uncertainty are more important towards explaining the unpredictability of real variables during recessions. The findings suggest upward surges in macroeconomic uncertainty as a driver of the excess volatility of real variables in emerging countries during recessions.

Other Papers

with Sylwia Nowak, International Monetary Fund

IMF Working Papers, Working Paper No. 16/228

Macroeconomic forecasts are persistently too optimistic. This paper finds that common factors related to general uncertainty about U.S. macrofinancial prospects and global demand drive this overoptimism. These common factors matter most for advanced economies and G- 20 countries. The results suggest that an increase in uncertainty-driven overoptimism has dampening effects on next-year real GDP growth rates. This implies that incorporating the common structure governing forecast errors across countries can help improve subsequent forecasts.