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Fear Thy Neighbor: Spillovers from Economic Policy Uncertainty^*

Abstract

High levels of economic policy uncertainty in various parts of the world revamped the debate about its impact on economic activity. With increasingly stronger economic, financial, and political ties among countries, economic agents have more reasons to be vigilant of foreign economic policy. Employing heterogeneous panel structural vector autoregressions, this paper tests for spillovers from economic policy uncertainty on other countries’ economic activity. Furthermore, using local projections, the paper zooms in on shocks originating in the United States, Europe, and China. Our results suggest that economic policy uncertainty reduces growth in real output, private consumption, and private investment, and that spillovers from abroad account for about two-thirds of the negative effect. Moreover, uncertainty in the United States, Europe, and China reduces economic activity in the rest of the world, with the effects being mostly felt in Europe and the Western Hemisphere.

Keywords: Economic policy uncertainty, China, Europe, private consumption, private investment, spillover, United States.

JEL Codes: D80, E32, F42.

Contents

• 1 Introduction

• 2 Data and Stylized Facts

• 3 Econometric Analysis

  • 3.1 Common and Idiosyncratic Effects of EPU

    • 3.1.1 Heterogeneous PSVAR

    • 3.1.2 Estimation Results

  • 3.2 Spillovers of EPU from the US, Europe, and China

    • 3.2.1 Local Projections

    • 3.2.2 Estimation Results

• 4 Robustness

  • 4.1 Heterogeneous PSVAR

  • 4.2 Local Projections

• 5 Conclusions

• References

• A Overview of EPU Sample

• B Data Sources and Country Groups

• List of Figures

  • 1 Heatmap of EPU

  • 2 EPU and Macroeconomic Aggregates

  • 3 Correlations between EPU in the US, Europe, and China and Regional Macroeconomic Aggregates (Percent)

  • 4 IRF Distribution from Heterogeneous PSVAR (Percent)

  • 5 Bootstrap of Heterogeneous PSVAR (Percent)

  • 6 Median Effect Decomposition from Heterogeneous PSVAR (Percent)

  • 7 Spillovers from an EPU Shock in the US, Europe, and China (Percent)

  • 8 Spillovers from an EPU Shock in the US across Regions with Annual Data (Percent)

  • 9 Spillovers from an EPU Shock in Europe across Regions with Annual Data (Percent)

  • 10 Spillovers from an EPU Shock in China across Regions with Annual Data (Percent)

  • 11 IRFs from Heterogeneous PSVAR with Controls for General Uncertainty, Activity, and Confidence (Percent)

  • 12 Inverted Ordering of Endogenous Regressors in Heterogeneous PSVAR

  • 13 Estimation of Heterogeneous PSVAR with Annual Data

  • 14 Estimation of Local Projections with Annual Data

• List of Tables

  • 1 Local Projections with Controls for Main Determinants of Y, PC, and PI with Annual Data (OLS FE)

  • 2 Local Projections at h = 4 with Controls for General Uncertainty, Activity, and Confidence

  • 3 Local Projections with Controls for Main Determinants of Y, PC, and PI with Annual Data (S-GMM)

  • A.1 EPU Sample

  • B.1 Data Sources

  • B.2 List of Countries by Region