Financial Shocks in an Uncertain Economy

Abstract: The past 15 years have been eventful. The Global Financial Crisis (GFC) reminded us of the importance of a stable financial system to a well-functioning economy, one with low and stable inflation and maximum employment. Given the recent banking stress, we ponder this issue again. The pandemic was a huge shock surrounded by much uncertainty, making precise forecasts within traditional models difficult. And more recently, there has been continuous talk of a soft landing and recession risks.

In this paper, I focus on some of the lessons we have learned over the years: (i) uncertainty and tail risk have cyclical variation; (ii) financial shocks can have a significant effect on macroeconomic outcomes; (iii) the impact of shocks is stronger in periods of high volatility.

These lessons have important implications for policymakers in today’s environment.

DOI: https://doi.org/10.24149/wp2308

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