Using Disasters to Estimate the Impact of Uncertainty

Scott R Baker, Northwestern University Kellogg School of Management and NBER, Nicholas Bloom, Stanford University and NBER, and Stephen Terry, Boston University and NBER

Uncertainty rises in recessions and falls in booms. But what is the causal relationship? We construct cross-country panel data on stock market returns to proxy for first- and second-moment shocks and instrument these with natural disasters, terrorist attacks, and political shocks. Our IV regression results reveal a robust negative short-term impact of second moments (uncertainty) on growth. Employing multiple VAR estimation approaches, relying on a range of identifying assumptions, also reveals a negative impact of uncertainty on growth. Finally, we show that these results are reproducible in a conventional micro-macro business cycle model with time-varying uncertainty.