The impact of economic policy uncertainty on financial cycle and business cycle: focusing on Korea

This study examines the dynamic relationship between global and domestic economic policy uncertainty (EPU) and Korea’s financial and business cycles over the period 1993:Q1–2023:Q4. A Bayesian time-varying parameter vector autoregression (TVP-VAR) framework is employed to capture evolving macro-financial interactions associated with major events such as the Global Financial Crisis (GFC) and the COVID-19 pandemic. Financial and business cycles are constructed using composite macro-financial indicators, while principal component analysis (PCA) is used as a robustness check. Structural shocks are identified through a recursive ordering of U.S. EPU, Korean EPU, the financial cycle and the business cycle. The results suggest that Korea’s macro-financial system has become increasingly sensitive to U.S. EPU shocks, particularly after the GFC. Domestic EPU shocks appear relatively short-lived and mainly operate through expectation channels. Financial cycles exhibit more persistent responses than business cycles, suggesting that financial conditions play an important role in propagating uncertainty shocks. Robustness checks using the VIX show broadly similar transmission patterns. Overall, the findings suggest the growing importance of external uncertainty and financial conditions in shaping macro-financial fluctuations in small open economies.