Ruhr Economic Papers

Ruhr Economic Papers #708

The Effects of Economic Policy Uncertainty on European Economies: Evidence from a TVP-FAVAR

by Jan Prüser and Alexander Schlösser

RGS, UDE, 07/2017, 30 S./p., 8 Euro, ISBN 978-3-86788-826-4 DOI: 10.4419/86788826

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Abstract

Recent events such as the financial and sovereign debt crisis have triggered an
increase in European Economic Policy Uncertainty (EPU). We use a TVP-FAVAR model
with hierarchical priors on the hyperparameters to investigate the effect of EPU on a
wide range of macroeconomic variables for eleven European Monetary Union (EMU)
countries. First, we find that EPU shocks are transmitted through various channels,
such as the real options-, the precautionary savings- and the financial channel.
Second, we are able to distinguish between a group of fragile countries (GIIPScountries)
and a group of stable countries (northern countries), where the former are
more strongly affected by EPU shocks. Third, while the IRFs for most variables differ
only in magnitude and not in sign between groups of countries, responses of long term
interest rates to EPU shocks have a different sign across countries. Fourth, we discover
that investors and traders react more sensitively than consumers to uncertainty. Fifth,
we find that EPU shocks affect monetary policy decisions. Sixth, we provide evidence
that the transmission of EPU shocks is quite stable over time. Finally, the increase in
EPU can partly be explained by the state of the European economy and should therefore
be treated as an endogenous variable.

JEL-Classification: C11, C32, E20, E60

Keywords: TVP-FAVAR; economic policy uncertainty; fat data; hyperparameter; European Monetary Union; hierarchical prior

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