Laurent Ferrara is a Professor of International Economics at SKEMA since September 2019. He teaches international economics and finance, risk assessment and financial econometrics. His research interests lie in the fields of international macroeconomics, business cycles, economic forecasting, and machine learning methods. He is currently investigating the role of commodity prices for macroeconomics as well as the global economic effects of climate change.  

Tell us about DEMUR, an ANR project tackling decision making under uncertainty?   

Laurent Ferrara: Uncertainty has become a major challenge that private and public decision makers must deal with. DEMUR is a research project aiming at analysing decision making under aggregate uncertainty to highlight the macroeconomic consequences of uncertainty through the lens of the behaviour of economic agents (companies, households, governments). 

What is your approach?  

Our global approach in this research project is based on the quantitative evaluation of the macroeconomic effects of uncertainty using economic modelling. This obviously requires first to be able to measure uncertainty. This is not an easy task as uncertainty in clearly not observable in the real world, so we must provide measures of uncertainty. It turns out that recently, we have seen a large increase in the number of indexes whose objective is to quantify overtime the degree of uncertainty in various sectors. We refer for example to financial uncertainty, macroeconomic uncertainty, economic policy uncertainty, geopolitical uncertainty, or cyber uncertainty. Then, we consider those various indexes and we put them into economic models that controls for standard economic relationships. This strategy allows us to evaluate and compare their impact on several markets.  

What are the outputs and outcomes of this project? 

The various research works that have been carried out within the DEMUR project led to two significant findings. First, an increase in uncertainty leads to a slowdown in economic activity, visible on various economic variables, in particular business investment, trade and household consumption. Overall, what we call the “business cycle” is adversely affected by uncertainty shocks. The effect is generally visible in the short run but can sometimes be persistent. This result has been verified for various measures of uncertainty, as for example commodity price uncertainty or trade uncertainty, and it holds for a variety of countries, both advanced and emerging countries. Those latter countries are generally much strongly affected, with less ability to bounce back once the uncertainty is solved. Last, we found that prices are susceptible of being impacted by uncertainty shocks, and not only real variables. In particular, the risk of inflation divergence within euro area countries tend to increase in the wake of uncertainty, making the job of the ECB much more difficult.  

Second, we show that uncertainty shocks have important implications for financial markets, particularly exchange rates. In particular, the risks around exchange rates tend to largely increase during periods of uncertainty. In addition, we show that for countries with a currency considered by financial markets as a commodity currency (e.g. Norway or Canada), a spike in commodity uncertainty systematically leads to a depreciation of their currency. This stylised fact is not visible on other currencies like the euro. 

We also identified another important source of uncertainty related to commodity prices, including energy, industrial and food commodities. A spike in commodity price uncertainty tends to generate a significant drop-in economic activity of countries, especially emerging economies that are net exporters of commodities. Interestingly, under certain conditions, we also show that an uncertainty surge in the energy sector is likely to support economic activity. This is an empirical illustration of the growth option theory, which suggests that in principle uncertainty shocks can encourage investment as it increases the size of the potential prize.   

The DEMUR project also gives us the possibility to organise events to bring together scholars to present and discuss their ongoing research and outcomes. Overall, DEMUR contributes to the actual policy debate about the impact of uncertainty on macroeconomic activity. It also improves the visibility of French universities and business schools within the academic community regarding this topical research subject.  

How does DEMUR impact society at large?

Overall, we get that uncertainty shocks are powerful drivers of business cycles, generally leading to negative effects on economic activity. They do have the ability to be detrimental for economic and financial activity in countries. Consequently, our recommendation to policymakers is to do their best to reduce ex ante spikes in uncertainty as the economic costs will likely be high.  

In this respect, policy measures aimed at eliminating or mitigating periods of long-lasting uncertainty fluctuations and setting up defences against the threat of future uncertainty fluctuations are thus appropriate. The traditional conception of stabilisation policies needs to be extended to account for fluctuations in uncertainty. The corollary to this is that uncertainty needs to be monitored in real-time using the various available measures. Also, policymakers are to be cautious with their communication through traditional media or social networks, as they could rapidly generate uncertainty.

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