Monetary Policy Uncertainty and its impact on the real economy: Empirical Evidence from the Euro area

Quelhas, João (2022): Monetary Policy Uncertainty and its impact on the real economy: Empirical Evidence from the Euro area.

Abstract

In this paper, we construct a proxy for uncertainty that tracks monetary policy in the Euro area by text-mining thousands of newspaper articles in the press. We calibrate a nonlinear interacted vector autoregression model to study the impact of monetary policy uncertainty on the real economy and on the effectiveness of monetary policy. We find that higher uncertainty leads to a contraction in economic activity, with a higher dampening effect in uncertain times. Uncertainty also influences how strongly movements in the policy rate affect output, investment and consumption as, in uncertain times, average responses are up to three times less powerful than in tranquil times.

• Item Type: MPRA Paper
• Language: English
• Keywords: Monetary Policy, Uncertainty, Euro Area, Textual Analysis, SEIVAR Model
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E40 - General; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E50 - General; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

References

[1] Aastveit, K. A., G. J. J. Natvik, and S. Sola (2013). Economic uncertainty and the effectiveness of monetary policy. Journal of International Money and Finance 76, 50–67.

[2] Alexopoulos, M., J. Cohen, M. Alexopoulos, and J. Cohen (2009). Uncertain times, uncertain measures. Working Paper.

[3] Arne, G. and Y. M. Largent (2016). The impact of macroeconomic uncertainty on activity in the euro area. Review of Economics 67, 25–52.

[4] Azqueta-Gavaldon, A., D. Hirschb ¨ uhl, L. Onorante, and L. Saiz (2020). Economic policy uncertainty in the euro area: An unsupervised machine learning approach. ECB Working Paper Series 2359.

[5] Azzimonti, M. (2018). Partisan conflict and private investment. Journal of Monetary Economics 93, 114–131.

[6] Bachmann, R., S. Elstner, and E. R. Sims (2013). Uncertainty and economic activity: Evidence from business survey data. American Economic Journal: Macroeconomics 5, 217–249.

[7] Baker, S. R., N. Bloom, and S. J. Davis (2016). Measuring economic policy uncertainty. The Quarterly Journal of Economics 131, 1593–1636.

[8] Bernanke, B. S. (1983). Irreversibility, uncertainty and cyclical investment. The Quarterly Journal of Economics, Oxford University Press 98, 85–106.

[9] Bloom, N. (2007). Uncertainty and the dynamics of r&d. The American Economic Review 97, 250–255.

[10] Bloom, N. (2009). The impact of uncertainty shocks. Econometrica 77, 623–685.

[11] Bloom, N. (2014). Fluctuations in uncertainty. The Journal of Economic Perspectives 28, 153–176.

[12] Bloom, N., D. Furceri, and H. Ahir (2018). The world uncertainty index. Stanford mimeo.

[13] Caggiano, G., E. Castelnuovo, and N. Groshenny (2014). Uncertainty shocks and unemployment dynamics in u.s. recessions. Journal of Monetary Economics 67, 78–92.

[14] Caggiano, G., E. Castelnuovo, and G. Pellegrino (2017). Estimating the real effects of uncertainty shocks at the zero lower bound. European Economic Review 100, 257–272.

[15] Caldara, D., M. Iacoviello, A. Kane, B. Cole-Smith, C. Singer, E. Markiewitz, F. Choudhary, J. Herman, L. Husted, M. Penn, P. Molligo, S. Conlisk, and T. Dhin (2021). Measuring geopolitical risk. Working Paper.

[16] Caldara, D., M. Iacoviello, P. Molligo, A. Prestipino, and A. Raffo (2019). The economic effects of trade policy uncertainty. International Finance Discussion Paper 2019, 1–49.

[17] Castelnuovo, E. and G. Pellegrino (2018). Uncertainty-dependent effects of monetary policy shocks: A new-keynesian interpretation. Journal of Economic Dynamics and Control 93, 277–296.

[18] Christiano, L., M. Eichenbaum, and C. Evans (1999). Monetary policy shocks: What have we learned and to what end? Journal of Political Economy 113, 1–45.

[19] Coibion, O., D. Georgarakos, Y. Gorodnichenko, G. Kenny, and M. Weber (2021). Working paper series the effect of macroeconomic uncertainty on household spending. ECB Working Paper Series.

[20] Dixit, A. and R. Pindyck (1994). Investment under Uncertainty. Princeton University Press.

[21] European Central Bank (2016). The impact of uncertainty on activity in the euro area.

[22] Eickmeier, S., N. Metiu, and E. Prieto (2016). Time-varying volatility, financial intermediation and monetary policy. CAMA Working Paper 32/2016.

[23] Ghirelli, C., J. J. Pérez, and A. Urtasun (2021). The spillover effects of economic policy uncertainty in latin america on the spanish economy. Latin American Journal of Central Banking 2, 100029.

[24] Husted, L., J. Rogers, and B. Sun (2016). Measuring cross-country monetary policy uncertainty. IFDP Notes, Board of Governors of the Federal Reserve System.

[25] Husted, L., J. Rogers, and B. Sun (2020). Monetary policy uncertainty. Journal of Monetary Economics 115, 20–36.

[26] Iskrev, N., R. Lourenc¸o, and C. Soares (2021). Indicators of monetary policy stance and financial conditions: an overview. Economic Bulletin and Financial Stability Report Articles and Banco de Portugal Economic Studies.

[27] Ivanov, V. and L. Kilian (2005). A practitioner’s guide to lag order selection for var impulse response analysis. Studies in Nonlinear Dynamics & Econometrics, De Gruyter 9, 1–36.

[28] Jurado, K., S. C. Ludvigson, and S. Ng (2015). Measuring uncertainty. The American Economic Review 105, 1177–1216.

[29] Keynes, J. M. (1937). The general theory of employment. Quarterly Journal of Economics 51, 209–223.

[30] Kilian, L. and R. J. Vigfusson (2011). Are the responses of the u.s. economy asymmetric in energy price increases and decreases? Quantitative Economics 2, 419–453.

[31] Koop, G., M. H. Pesaran, and S. M. Potter (1996). Impulse response analysis in nonlinear multivariate models. Journal of Econometrics 74, 119–147.

[32] Leduc, S., Z. Liu, S. Leduc, and Z. Liu (2016). Uncertainty shocks are aggregate demand shocks. Journal of Monetary Economics 82, 20–35.

[33] Nodari, G., Nodari, and Gabriela (2014). Financial regulation policy uncertainty and credit spreads in the US, Journal of Macroeconomics 41, 122–132.

[34] Pellegrino, G. (2018). Uncertainty and the real effects of monetary policy shocks in the euro area. Economics Letters 162, 177–181.

[35] Pellegrino, G. (2021). Uncertainty and monetary policy in the us: A journey into nonlinear territory. Melbourne Institute Working Paper 6.

[36] Sims, C. A. (1980, 1). Macroeconomics and reality. Econometrica 48, 1.

[37] Sims, C. A., J. H. Stock, and M. W. Watson (1990). Inference in linear time series models with some unit roots. Econometrica 58, 113–144.

[38] Stock, J. H. and M. W. Watson (2001). Vector autoregression. Journal of Economic Perspectives 15, 101–115.

[39] Wu, J. C. and F. D. Xia (2016). Measuring the macroeconomic impact of monetary policy at the zero lower bound. Journal of Money, Credit, and Banking 48, 253–291.