Uncertainty and Business Cycle: An Empirical Analysis for Uruguay

Abstract

As a small and open economy, Uruguay is highly exposed to international and regional shocks that affect domestic uncertainty. To account for this uncertainty, we construct two geometric uncertainty indices (based on the survey of industrial expectations about the economy and the export market) and explore their association with the Uruguayan GDP cycle between 1998 and 2022. Based on the estimated linear ARDL models that showed negative but weak relationships between the uncertainty indices and the GDP cycle, we test for the existence of structural breaks in these relationships. Although we find a significant break in 2003 for both indices and another in 2019 for one of them, Wald tests performed on the non-linear models only confirm the structural break in the early 2000s in the model with the index based on export market expectations. In this non-linear model, we find that the negative influence of uncertainty fades after 2003. The evidence of a differential influence before and after this date remains, even when controlling for the variability in non-tradable domestic prices. Two implications arise from these results. First, the evidence of relevant changes that made the Uruguayan economy less vulnerable from 2003 onward. Second, the importance of the expectation about the future of the export market in the macroeconomic cycle of a small and open economy like Uruguay.