Implications of macroeconomic volatility in the Euro area

TL;DR

This paper uses a Bayesian VAR model with stochastic volatility to analyze how macroeconomic uncertainty shocks impact Euro area countries, revealing significant declines in activity and financial indicators following such shocks.

Contribution

It introduces a joint estimation of uncertainty and macroeconomic effects using a Bayesian VAR with factor stochastic volatility, focusing on the Euro area as a whole.

Findings

Real activity decreases for all countries after an uncertainty shock.

Equity prices, interest rates, and exports decline; unemployment rises.

Reactions vary slightly across countries in magnitude and duration.

Abstract

In this paper we estimate a Bayesian vector autoregressive model with factor stochastic volatility in the error term to assess the effects of an uncertainty shock in the Euro area. This allows us to treat macroeconomic uncertainty as a latent quantity during estimation. Only a limited number of contributions to the literature estimate uncertainty and its macroeconomic consequences jointly, and most are based on single country models. We analyze the special case of a shock restricted to the Euro area, where member states are highly related by construction. We find significant results of a decrease in real activity for all countries over a period of roughly a year following an uncertainty shock. Moreover, equity prices, short-term interest rates and exports tend to decline, while unemployment levels increase. Dynamic responses across countries differ slightly in magnitude and duration, with Ireland, Slovakia and Greece exhibiting different reactions for some macroeconomic fundamentals.