Nils Gornemann, Eugenio Rojas, Felipe SaffieDoes global financial risk affect long-run growth? Using a panel state-space model for emerging and advanced small open economies, we measure the effects of U.S. monetary policy uncertainty shocks. A one-standard-deviation shock lowers the level of the stochastic trend in emerging markets by at least 25 basis points after three years, with little effect in advanced economies. A small open economy model with growth through innovation and occasionally binding borrowing constraints explains this heterogeneity: higher interest-rate volatility depresses valuations, tightens collateral constraints, and slows innovation in equilibrium. A novel interaction between the occasionally binding constraint and stochastic volatility is key for our results.
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