Regime‐dependent effects of uncertainty shocks: A structural interpretation

Using a Markov‐switching VAR, we show that the effects of uncertainty shocks on output are four times higher in regime economic distress than tranquil regime. We then provide structural interpretation these facts. To do so, develop business cycle model which agents aware possibility changes when forming expectations. The is estimated using Bayesian minimum distance estimator minimizes, over set parameters, between regime‐switching VAR‐based impulse response functions and those implied by model. Our results point to worsening credit‐market conditions amplify during periods. Finally, expectation effect switching financial an important component accelerator mechanism. If more pessimistic about future conditions, amplified.