Uncertainty spill-overs: When policy and financial realms overlap

No matter its source, financial- or policy-related, uncertainty can feed onto itself, leading to identification challenges in empirical applications. We add to the stock of analytical methods able to disentangle among various types of uncertainty shocks by proposing an identification approach based on a combination of zero and absolute magnitude restrictions implemented in a multicountry setting. We find evidence of sizable spill-overs within the Euro Area (EA) arising from country-specific uncertainty shocks, with financial realm being a more important source than the policy realm. By leveraging on the flexibility of our approach, we show how important is a correct identification of each uncertainty shock type. A comparison between the on-impact responses of sovereign yields for EA members and non-members suggests that the common currency area likely features institutional arrangements and mechanisms that can initially blur the thin line separating uncertainty shock types. Because we find ECB reactions were not likely to be conditioned by the type of the uncertainty shock hitting a particular country, but by its potential to spill over abroad, we believe ECB has filled the leadership vacuum by doing "whatever it takes" to prevent fragmentation of the EA.