The impact of uncertainty shocks in South Africa: The role of financial regimes

Abstract

This article examines the connection between economic uncertainty and financial market conditions in South Africa, documenting that the macroeconomic implications of an uncertainty shock differ across financial regimes. A non-linear VAR is estimated where uncertainty is captured by the average volatility of structural shocks in the economy, and the transmission mechanism is characterized by two distinct financial regimes (i.e., financially stressful vs. normal periods). We find that while the deterioration of output following an uncertainty shock is much more prominent during normal periods than during stressful periods, it is much more persistent during stressful financial times. The share of output variance explained by the volatility shocks in normal financial times is more than double the share in stressful times. Uncertainty shocks are found to be inflationary in both regimes, with the impact being larger in the stress regime. While our estimates reveal that financial frictions do not amplify the impact of uncertainty on real output, it does increase the impact on prices.