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

This paper asks two questions “Does there exist heterogeneity in the response of macro variables to uncertainty shocks across advanced and emerging countries? and, “How important is the state of the economy for the effects of an uncertainty shock?. I analyze the recession-specific effects of uncertainty for a sample of 8 countries – the US, UK, France, Canada, Mexico, Chile Argentina, and South Korea. The results emphasize asymmetries along two dimensions – (1) An uncertainty shock disproportionately increases the depth and duration of a recession for an emerging country vis-`a-vis an advanced economy. Furthermore, I find that openness to trade exacerbates this decline and subsequently the pace of recovery in emerging countries in comparison to advanced economies. (2) Controlling for the state of the economy is crucial when quantifying the effects of an uncertainty shock. I show that a linear model – without regime differentiation – consistently underestimates the response of macroeconomic variables to uncertainty shocks when compared with the predictions from the recessionary regime of the nonlinear model. The extent of this under prediction is again disproportionately larger for emerging countries. The results in conjunction can potentially explain the excess volatility of macro variables for emerging countries during recessionary episodes.