Macroeconomic effects of political risk shocks

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 20 December 2019

Staff Working Paper No. 841

By Sinem Hacioglu Hoke

We investigate the macroeconomic effects of political risk in an information-rich SVAR. Using an external instrument based on an index of US partisan conflict for identification, we find that reduced political risk has expansionary impact: it is immediately priced into stock prices; increases firms’ credit availability, employment and investments while households invest and consume more — ultimately output rises. As an important driver of economic dynamics in medium to long term, the shock creates an aggregate supply effect where output growth and inflation move in opposite directions, and generates a trade-off between inflation stabilization and output growth during turbulent periods. 

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