Threshold effects of macroeconomic uncertainty on monetary policy in G7 countries

Abstract

Macroeconomic uncertainty poses significant challenges for policymakers, especially in the context of designing effective monetary policy. Despite extensive research on the effects of macroeconomic uncertainty on economic outcomes, the specific thresholds at which macroeconomic uncertainty influences policy decisions remain underexplored. This study addresses this gap by examining the threshold effects of macroeconomic uncertainty proxied with economic policy uncertainty on monetary policy in G7 countries. Using quarterly data from 2000 to 2024 and employing the Structural Vector Autoregression (SVAR) model, we uncover a distinct uncertainty threshold that divides the sample into two regimes: low-macroeconomic uncertainty and high-macroeconomic uncertainty periods. Our results reveal that policymakers face a critical dilemma during high-macroeconomic uncertainty periods, where the effects of macroeconomic uncertainty shocks on key macroeconomic variables are significantly amplified. By identifying and quantifying these threshold effects, we contribute new insights into how macroeconomic uncertainty alters the effectiveness of monetary policy. This study further emphasizes the importance of adaptive and responsive policy frameworks, particularly when financial markets are unstable. These results are crucial for policymakers and researchers aiming to better understand and navigate the complex dynamics of macroeconomic uncertainty in monetary policy formulation.