Bank liquidity and the propagation of uncertainty in the U.S

Does the banking sector matter for the propagation of uncertainty? We apply local projections to study the dynamic response of U.S. real GDP to exogenous changes in uncertainty conditional on the liquidity of the banking sector. We find that uncertainty has a stronger impact when the banking sector is less liquid. Additional analyses show that bank lending is more adversely affected in the case of low bank liquidity and that external finance-dependent sectors respond more markedly to uncertainty shocks. We conclude that the provision of bank loans plays an important role in the transmission of uncertainty. •We evaluate the transmission of uncertainty to real GDP through the banking sector.•We find state-dependent effects of uncertainty conditional on banking sector liquidity.•Uncertainty exerts stronger and more persistent effects during periods of low liquidity.•In the low liquidity state output responds 40%–60% stronger than in the linear model.•Our analysis suggests that uncertainty is transmitted through loan supply.