Does Financial Stability Withstand Economic Policy Uncertainty? Insights From Linear and Nonlinear Patterns

ABSTRACT This study examines the impact of Economic Policy Uncertainty (EPU) on Financial Stability (FS) in developed and emerging economies from 2003 to 2022. Using a balanced panel dataset and multiple statistical methods, the results reveal a nonlinear association between EPU and FS. At low to moderate levels, EPU reduces financial stability, but beyond a certain point, higher EPU improves FS. The findings suggest that rising EPU prompts regulators and institutions to respond in order to protect FS. Sub‐sample analysis shows that this nonlinear effect becomes more pronounced in emerging economies, where financial systems remain more vulnerable and sensitive to shocks. Additional tests reveal that emerging markets respond more sharply to changes in uncertainty, while developed markets exhibit a weaker response, reflecting the strength of their financial systems. The study findings remain robust across a range of alternative measures and advanced estimators, including the generalized method of moments, spline regression, and panel‐corrected standard errors. The study offers crucial policy insights by highlighting the need for tailored regulatory frameworks to mitigate the harmful effects of EPU on FS. By distinguishing between developed and emerging economies, this research enhances our understanding of financial resilience in the face of economic uncertainty and contributes to ongoing debates on macroeconomic stability.