Macroeconomic effects of political risk shocks
Bank of England 2019.12.24
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.