What Is the Impact of Heightened Economic Policy Uncertainty and Adverse Financial Conditions on the Manufacturing Sector?

Abstract

What is the impact of heightened economic policy uncertainty and adverse financial conditions on the manufacturing sector? Evidence in this chapter shows that the manufacturing sector output growth, investment growth and employment growth decline in response to heightened economic policy uncertainty and adverse financial conditions. In addition, the counterfactual scenarios show that the R/US$ exchange rate volatility and the tight financial conditions channels amplify the adverse shock effects of heightened economic uncertainty shocks on activity in the manufacturing sector. These results imply that the concurrence of heightened economic uncertainty, tight financial conditions and high exchange rate volatility shocks is not good for the manufacturing sector. Uncertainty shocks via the financial frictions channel tend to induce a wait and see approach by firms with adverse effects on economic activity. The financial frictions channel provides additional mechanism through which uncertainty shocks affect the economy by increasing the risk premium. Thus, policymakers have to adopt policies that reduce economic policy uncertainty. This is important because uncertainty shocks have a significant macroeconomic impact in cases where they elicit a tightening of financial conditions. Tight financial conditions shocks have a significant adverse effect on economic outcomes.