How High Economic Uncertainty May Threaten Global Financial Stability

IMF Blog, October 15, 2024

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High and persistent economic uncertainty—driven by pandemic disruption, the surge in inflation, fraying geopolitics and war, climate disasters, and rapidly evolving technologies—raises the risk of financial market volatility and a sharp decline in economic growth.
Economists use proxies such as the Economic Policy Uncertainty Index (counts news stories citing uncertainty, the economy, and policy) and measures that track the difference between published economic data and prior economist projections to quantify uncertainty.

Economic uncertainty indices and financial market volatility can diverge; disconnects between high economic uncertainty and low financial market volatility can persist over time.
A sustained disconnect raises the risk that an adverse shock will produce a sudden jump in financial market volatility and a large drop in asset prices.

If measures of economic uncertainty were to climb like they did during the global financial crisis, then the lowest decile of potential outcomes for economic growth (downside tail risk) would drop by 1.2 percentage points.
Illustrative impact: "If the global economy was projected to grow by 0.5 percent in an adverse scenario, it would now be expected to contract by 0.7 percent."

Economic impacts from elevated uncertainty vary across countries and can be amplified when public and private debt levels are elevated relative to the size of a given economy.
High uncertainty can exacerbate the macro-financial stability tradeoff associated with loose financial conditions:
- Easier financial conditions typically raise expectations for economic growth and reduce first-year downside risks (via lower interest rates, higher asset valuations, narrower credit spreads, and reduced stock market volatility).
- However, easy financial conditions increase debt vulnerabilities, which can worsen downside risks to economic growth further ahead.

High economic uncertainty can generate spillover effects through trade and financial linkages, with the potential to trigger international financial contagion.

Enhance policy credibility:
- Adopt fiscal and monetary policy rules backed by strong institutions to provide more certainty.
- Use greater transparency and well-designed policy communication frameworks to better guide market expectations and make policy decisions and their transmission more predictable.
Use macroprudential and fiscal policy proactively:
- Apply adequate macroprudential policies to limit risks that are amplified when financial conditions are loose and appear disconnected from elevated economic uncertainty.
- Prioritize fiscal sustainability to prevent elevated public debt levels from raising borrowing costs that could undermine macro-financial stability.

Source: Chapter 2 of the October 2024 Global Financial Stability Report, “Macrofinancial Stability Amid High Global Economic Uncertainty.”