Research

Uncertainty Shocks, Financial Frictions, and Business Cycle Asymmetries Across Countries 

Online Supplement 

European Economic Review, 2024

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. 

The Interaction Between Credit Constraints and Uncertainty Shocks 

with David Gunawan and Robert Kohn

Journal of Money Credit and Banking, 2024

This article proposes a novel link between credit markets and uncertainty shocks. We introduce a role for credit uncertainty via collateral constraints in an otherwise standard RBC model, and show that an increase in credit uncertainty triggers a precautionary response that interacts with the binding collateral constraint to generate a simultaneous decline in output, consumption, investment, real wages, and hours; a feature that previous work on uncertainty shocks without credit constraints is unable to produce in a flexible price environment. We also empirically test the theoretical predictions and show that an unforeseen increase in credit uncertainty generates a simultaneous decline in a broad measure of real activity in recessions.

The Block-Correlated Pseudo Marginal Sampler for State Space Models  

with David Gunawan and Robert Kohn

Journal of Business Economics and Statistics, 2024

Our article develops an efficient PMMH method, which we call the multiple PMMH (MPM) algorithm, for estimating the parameters of complex state space models. Several important innovations are proposed.  First, the multiple particle filters are run in parallel, and the trimmed means of their unbiased likelihood estimates are used. Second, a novel block version of PMMH that works with multiple particle filters is proposed. Third, the article develops an efficient auxiliary disturbance particle filter, which is necessary when the bootstrap disturbance filter is inefficient, but the state transition density cannot be expressed in closed form. Fourth, a novel fast sorting algorithm is developed to preserve the correlation between the logs of the likelihood estimates at the current and proposed parameter values. These features enable our sampler to scale up better to higher dimensional state vectors than previous approaches. The performance of the sampler is investigated empirically by applying it to non-linear Dynamic Stochastic General Equilibrium models with relatively high state dimensions and with intractable state transition densities and to multivariate stochastic volatility in the mean models. Although our focus is on applying the  method to state space models, the approach will be useful in a wide range of applications such as large panel data models and stochastic differential equation models with mixed effects.

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

Journal of Economic Behavior and Organization, 2020

with Fabio Milani

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.

Asymmetric Impact of Uncertainty in Recessions - Are Emerging Countries More Vulnerable?  

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.

Belief-Driven Monetary Policy Transmission – A Sentiment Channel

This article examines how macroeconomic sentiment shapes the transmission of monetary policy. Using smooth diagnostic expectations to motivate a role for sentiments in DSGE models, I show that overreaction relative to a rational benchmark generates an additional transmission channel: an interaction between excess optimism or pessimism and monetary policy shocks that operates over and above conventional mechanisms. By mapping theory to data using forecast uncertainty ratios, I provide empirical evidence that this overreaction-driven interaction effect is quantitatively significant and alters the trajectories of macro and financial variables in response to monetary policy shocks, as identified in earlier work. The sentiment channel influences economic activity through financial markets, amplifying or dampening borrowing costs depending on whether optimism or pessimism prevails. The findings offer a framework for quantifying the impact of sentiment on monetary policy transmission, thereby isolating the mechanisms that generate fluctuations in policy potency.

Forecast Errors and Uncertainty Shocks -IMF Working Papers, Working Paper No. 16/228

with Sylwia Nowak, International Monetary Fund

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.