Geopolitical risk shocks : when the size matters

In this paper, we investigate the presence of non-linearities in the transmission of geopolitical risk (GPR) shocks. Our methodology involves incorporating a non-linear function of the identified shock into a VARX model and examining its impulse response functions and historical decomposition. We find that the primary transmission channel of such shocks is associated with heightened un-certainty, which significantly escalates only with substantially large GPR shocks (i.e., above 4 standard deviations). This increase in uncertainty prompts pre-cautionary saving behaviors, exerting a strong impact on consumption and reducing activity. The response of inflation is more subdued, reflecting both diminished demand and heightened uncertainty, which influence prices in op-posing directions.