The effect of macroeconomic uncertainty on Southern European countries

The effect of macroeconomic uncertainty on economic activity is one of the most significant issues for economic actors, and policymakers have recently attracted more attention to uncertainty in their decision-making process. Macroeconomic uncertainty brings hefty costs to individuals' behaviors, firms' operations, and policymakers' decisions. Considering the complex structure of the economy, it is hard to measure economic uncertainty. However, in recent years, the number of studies on the quantitative measurement of uncertainty has increased. Macroeconomic uncertainty index, which includes different macroeconomic activities and sectors, provides a comprehensive and alternative perspective, and contains more information about the real economy, and therefore increases the inclusiveness of uncertainty. In the era of increasing uncertainty due to the 2008 Global Financial Crisis and the 2010 Eurozone sovereign debt crisis, the deepening of the North-South divide in the EU makes it more important for GIIPS (Greece, Ireland, Italy, Portugal, Spain) countries to investigate the effect of uncertainty on economic activity. Only one study (Mumtaz and Musso, 2021) in the literature examines the effects of US, EU, and GIIPS country-level uncertainties on the economic activities of GIIPS countries within the same model. In addition, there is no study that uses different conditional variance techniques and Principal Component Analysis (PCA) method to measure macroeconomic uncertainties in the EU and GIIPS countries. For these reasons, the aim of our thesis is to investigate the effects of macroeconomic uncertainties in the US, EU and GIIPS countries on the industrial production of GIIPS countries. First, I calculated the uncertainties of US, EU, and GIIPS countries' various macroeconomic indicators. Then, I constructed the uncertainty indices for the US, EU, and GIIPS countries by using PCA. Finally, I estimated the impact of the US, EU, and GIIPS uncertainties on industrial production in the GIIPS countries with the utilization of the Vector Autoregressive (VAR) method and Impulse Response (IR) analysis. The results indicate that an increase in US macroeconomic uncertainty has a positive effect on the industrial production in GIIPS countries, but the effect is statistically significant in Italy, Portugal, and Spain. Also, EU economic uncertainty has a positive effect on the industrial production of Ireland, Spain, and Portugal while a negative impact on industrial production of Italy and Greece. However, the effect is statistically significant on the industrial production of Spain and Portugal. Institutional structure of the Irish economy with respect to regulation quality, government efficiency, and political stability is stronger than other EU countries, and this might explain that industrial production in Ireland is affected other than uncertainty factors. Also, the lower share of industrial production in the Greek economy shows that economic activity in Greece is not affected by the US and EU macroeconomic uncertainties. According to the findings obtained from impulse response analysis, macroeconomic uncertainties in Spain, Portugal, and Greece have a negative impact on the industrial production of these countries. These results support the Real Option theory, which argues that increased uncertainty causes a delay in investment and a decrease in employment, and therefore a fall in output. Overall, when country-specific uncertainty rises in Spain, Portugal and Greece, policy makers should implement policies that encourage investment and production, which takes the budget deficits and public debts into account. On the other hand, as the US and EU macroeconomic uncertainties increases, policy makers in the GIIPS countries should carry out regulations that increase the quality of production instead of decreasing production costs through internal devaluation with austerity measures in labor markets.