## Online Annex 1. Economic Implications of Uncertainty in Latin America and the Caribbean

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**Canonical URL:** [Online Annex 1. Economic Implications of Uncertainty in Latin America and the Caribbean](https://www.imf.org/-/media/files/publications/reo/whd/2025/october/english/ch1onlineannex.pdf)

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### Introduction
- Presents technical details and background material for the analysis in Chapter 1 “Navigating a Shifting Global Environment” of the October 2025 Regional Economic Outlook for the Western Hemisphere.
- Major shifts in trade policy have heightened global economic uncertainty, with a significant share of the rise in uncertainty for LAC stemming from sources outside the region.
- Elevated uncertainty exerts a lagged yet negative impact on economic activity, especially in countries with weak institutions and high debt.
- Prepared by Eric Huang.

### Measurement and decomposition of uncertainty
- Uncertainty measured using the World Uncertainty Index (WUI), a quarterly panel dataset covering 143 countries—20 of which are from LAC.
- WUI is calculated by counting the frequency of the word “uncertainty” and its synonyms in Economist Intelligence Unit reports, adjusted for total word count.
- A dynamic factor model (based on Stock and Watson (2011)) decomposes each country’s WUI into:
  - a global factor (common to all countries),
  - a regional factor (region-specific, orthogonal to global shocks),
  - an idiosyncratic factor (country-specific).
- The surge in uncertainty since end-2024 is largely driven by a global and synchronized factor; uncertainty spiked since the start of 2025, particularly after the US tariff announcements in April.
- The global factor accounted for the bulk of the increase both globally and within LAC, with pronounced effects in more open economies such as Mexico and Central America, Panama, and the Dominican Republic (CAPDR).

### Methodology for estimating economic effects
- Uses the local projections approach by Jordà (2005) to estimate impulse responses of (log) real GDP to uncertainty shocks:
  - Dependent variable: 푦푦푖,푡+ℎ − 푦푦푖,푡−1 where 푦푖,푡 denotes (log) real GDP in country i and year t, and h is the horizon.
  - Uncertainty measures: global, regional, idiosyncratic factors, or country-level WUI.
  - Controls: (log) trade openness, terms of trade, export partners’ growth, epidemics, natural disasters, conflicts, and country/time fixed effects.
  - Standard errors clustered at the country level.
- Interaction specification incorporates pre-existing vulnerability dummy 푃푖,푡 to capture high debt, weak control of corruption, high inflation volatility, and low monetary policy independence.

### Main findings: Impact of uncertainty on LAC economic activity
- Estimates indicate a delayed but persistent negative impact on economic activity in LAC:
  - The effect is gradual: not significant on impact but becomes increasingly negative over time.
  - The peak effect of each factor tends to occur two-three years after the shock.
  - The country-level WUI impact is notably more persistent.
- Quantified comparison:
  - A one-standard-deviation increase in WUI is associated with a 1 percent decline in real GDP growth in LAC three years after the shock.
  - In comparison, the estimated impact is around 0.5 percent or less for Middle East and Central Asian countries and the rest of the world (per Chapter 2 of the May 2025 Regional Economic Outlook: Middle East and Central Asia).
- Negative effects in LAC are more pronounced than those previously documented for other regions.

### Domestic vulnerabilities that amplify effects
- Pre-existing vulnerabilities increase the severity of uncertainty shocks:
  - High debt: a country is classified as having high debt when its debt-to-GDP ratio is above its income group’s median.
  - Weak control of corruption: when its corruption measure is below the global median.
  - High inflation volatility: when its 5-year rolling inflation volatility exceeds the global median.
  - Low monetary policy independence: when the central bank monetary policy independence index is below the global median.
- Empirical findings:
  - Countries with weak anti-corruption institutions, fragile monetary policy frameworks (high inflation volatility and limited monetary policy independence), and elevated debt-to-GDP ratios experience more severe effects from uncertainty shocks.
  - High debt limits fiscal space and constrains the effectiveness of monetary policy frameworks, reducing the government’s ability to cushion the economy when shocks hit.
  - Weaker governance undermines policy credibility and effectiveness.
  - Less vulnerable countries are more resilient: uncertainty shocks have limited and often insignificant economic effects in those countries.

### Policy implications and recommendations
- Heightened uncertainty increases the value of strengthening macroeconomic and institutional frameworks.
- Short-term and medium-term priorities:
  - Cope with short-term risks from trade shocks.
  - Advance medium-term reforms to strengthen institutions and enhance policy frameworks.
  - Maintain fiscal consolidation to preserve fiscal space and resilience.
- Strengthening anti-corruption institutions, improving monetary policy independence, and reducing debt-to-GDP ratios can mitigate the persistent adverse effects of uncertainty.

*INTERNATIONAL MONETARY FUND | Regional Economic Outlook—Western Hemisphere, Online Annex 1, October 2025.*

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_Source: https://www.imf.org/-/media/files/publications/reo/whd/2025/october/english/ch1onlineannex.pdf_