Macroeconomics Seminar - Pratiti Chatterjee (University of New South Wales)

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

Abstract: Uncertainty shocks trigger sharper declines in consumption, investment, GDP and a stronger countercyclical response in trade-balances in emerging countries compared to advanced economies. I propose and estimate a nonlinear open-economy model with financial frictions to reconcile these stylized facts in a micro-founded environment. Estimating this nonlinear model using data for 8 countries I find that heightened uncertainty is common across advanced and emerging countries during recessions however higher financial frictions is key towards generating the observed excess volatility in emerging countries. I find borrowing costs to be 592 basis points higher in emerging countries during downturns vis-à-vis advanced economies. To mitigate the negative impact of uncertainty, I propose a countercyclical subsidy on borrowing costs and show that this policy dampens the change in borrowing costs and consequently reduces the severity of the recession.