U.S. economic uncertainty, EU business cycles, and the global financial crisis

• Author: Syed S. Hassan,Taufiq Choudhry,Sarosh Shabi
• DOI: http://doi.org/10.1002/ijfe.1726
• Date: 01 January 2020
• Published date: 01 January 2020

RESEARCH ARTICLE

U.S. economic uncertainty, EU business cycles, and the

global financial crisis

Taufiq Choudhry

1

| Syed S. Hassan

2

| Sarosh Shabi

2

1

School of Business, University of

Southampton, Southampton, UK

2

School of Management, Swansea

University, Swansea, UK

Correspondence

Syed S. Hassan, Swansea University,

School of Management, Swansea, UK.

Email: s.shabi‐ul‐hassan@swansea.ac.uk

Funding information

National Science Centre, Poland, Grant/

Award Number: UMO‐2014/13/B/HS4/

01556

Abstract

This paper investigates the impact of the U.S. economic uncertainty on the busi-

ness cycles (changes in the industrial production) of 12 European Union (EU)

countries before and during the global financial crisis. Empirical tests are con-

ducted using the linear and non‐linear causality tests, impulse response func-

tion, and variance decomposition. Results show ample evidence of causality

from the U.S. uncertainty to EU business cycles only when the crisis period is

included in the analysis. Both the linear and non‐linear tests confirm the signif-

icance of U.S. uncertainty as a short‐term predictor of business cycles of the EU.

KEYWORDS

business cycles, Jurado index, non‐linear causality, uncertainty

JEL CLASSIFICATION

E3; E32

1|INTRODUCTION

Research interest in the economic uncertainty modelling

and its role in predicting macroeconomic fluctuations have

revived in the recent years (Baker, Bloom, & Davis, 2015;

Caldara, Fuentes‐Albero, Gilchrist, & Zakrajsek, 2016;

Dzielinski, 2012; Jurado, Sydney, & Serena, 2015). During

periods of financial crisis, economic uncertainty arises

because of negative news, which lowers expectations of

future economic activity. During the recent global finan-

cial crisis, the United States experienced an exceptional

increase in macroeconomics and financial uncertainty

(Cesa‐Bianchi, Pesaran, & Rebucci, 2014). Caldara et al.

(2016) claim that the global financial crisis has cast doubt

on the traditional sources of business cycles (BCs) fluctua-

tions.

1

And, in response, recent research have pointed to

economic uncertainty as alternative driver of economic

fluctuation (Bloom, 2009; Bloom, Floetotto, Jaimovich,

Saporta‐Eksten, & Terry, 2014; Christiano, Motto, &

Rostagno, 2014; Gilchrist, Sim, & Zakrajšek, 2014).

Lately, uncertainty has been defined in two different

ways. First, according to Jurado et al. (2015), uncertainty

is defined as the conditional volatility of a stochastic pro-

cess that is not forecastable from the perspective of eco-

nomic agents. Alternatively, Bloom (2009) and Baker

et al. (2015) defined uncertainty as a situation where

future state of the economy is not known with certainty.

2

They also report that the economic uncertainty is coun-

tercyclical; that is, uncertainty on average is much lesser

in the expansionary times as compared with the reces-

sions. This paper studies the effect of the global financial

crisis on the spillover effect of the U.S. economic uncer-

tainty on the European Union (EU) BCs.

An increase in economic uncertainty can produce an

adverse effect on the economy by reducing employment,

investment, and output through various channels (Baker

et al., 2015; Bloom, 2009; Born & Pfeifer, 2014; Colombo,

2013; Jurado et al., 2015). Some of the channels identified

in the existing literature are (a) real options effect

(Bernanke, 1983), (b) precautionary savings effect (Leland,

1968), and (c) financial frictions effect (Gilchrist et al.,

2014). On the demand side, higher uncertainty leads to

reduction in investment demand for firms and delays in

the new projects. This is because the firms gather new

Received: 2 January 2017 Revised: 4 October 2018 Accepted: 21 March 2019

DOI: 10.1002/ijfe.1726

wileyonlinelibrary.com/journal/ijfe

IntJ Fin Econ.2020;25:28–42.

© 2019 John Wiley & Sons, Ltd.

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