RWP 14-15, November 2014; Revised November 2016
Can increased uncertainty about the future cause a contraction in output and its components? An identified uncertainty shock in the data causes significant declines in output, consumption, investment, and hours worked. Standard general-equilibrium models with flexible prices cannot reproduce this comovement. However, uncertainty shocks can easily generate comovement with countercyclical markups through sticky prices. Monetary policy plays a key role in offsetting the negative impact of uncertainty shocks during normal times. Higher uncertainty has even more negative effects if monetary policy can no longer perform its usual stabilizing function because of the zero lower bound. We calibrate our uncertainty shock process using fluctuations in implied stock market volatility and show that the model with nominal price rigidity is consistent with empirical evidence from a structural vector autoregression. We argue that increased uncertainty about the future likely played a role in worsening the Great Recession.
JEL Classification: E32, E52
Article Citation
- Basu, Susanto, and Brent Bundick. 2015. PDF“Uncertainty Shocks in a Model of Effective Demand,” Federal Reserve Bank of Kansas City, working paper no. 14-15, November, available at: External Linkhttps://doi.org/10.18651/RWP2014-15
Related Research
- Basu, Susanto, and Brent Bundick. 2015. PDF"Endogenous Volatility at the Zero Lower Bound: Implications for Stabilization Policy." Federal Reserve Bank of Kansas City, working paper no. 15-1.
- Fernández-Villaverde, Jesús, Pablo Guerrón-Quintana, Keith Kuester, and Juan Rubio-Ramırez. 2012. External Link"Fiscal Volatility Shocks and Economic Activity." Federal Reserve Bank of Philadelphia, working paper no. 11-32R.
- Bloom, Nicholas, Max Floetotto, Nir Jaimovich, Itay Saporta-Eksten, and Stephen J. Terry. External Link"Really Uncertain Business Cycles." National Bureau of Economic Research, No. w18245, available at 10.3386/w18245.
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