SOVEREIGN UNCERTAINTY

Abstract

This article investigates the impact and transmission of uncertainty regarding the future path of government finances on economic activity. Employing a data-rich approach, I introduce a novel proxy that captures uncertainty surrounding public finances, which I refer to as sovereign uncertainty. In an application to Spain, sovereign uncertainty shocks persistently dampen the economy in the medium run, whereas macro-financial uncertainty shocks originating in the private sector induce a negative short-lived response in real activity. In addition, a New Keynesian model rationalizes the empirical results, emphasizing the role of financial frictions and monetary policy decisions in transmitting the effects of sovereign uncertainty shocks.