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The Impact of Uncertainty Shocks

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Author Info
Nicholas Bloom

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Abstract

Uncertainty appears to jump up after major shocks like the Cuban Missile crisis, the assassination of JFK, the OPEC I oil-price shock and the 9/11 terrorist attack. This paper offers a structural framework to analyze the impact of these uncertainty shocks. I build a model with a time varying second moment, which is numerically solved and estimated using firm level data. The parameterized model is then used to simulate a macro uncertainty shock, which produces a rapid drop and rebound in aggregate output and employment. This occurs because higher uncertainty causes firms to temporarily pause their investment and hiring. Productivity growth also falls because this pause in activity freezes reallocation across units. In the medium term the increased volatility from the shock induces an overshoot in output, employment and productivity. Thus, second moment shocks generate short sharp recessions and recoveries. This simulated impact of an uncertainty shock is compared to VAR estimations on actual data, showing a good match in both magnitude and timing. The paper also jointly estimates labor and capital convex and non-convex adjustment costs. Ignoring capital adjustment costs is shown to lead to substantial bias while ignoring labor adjustment costs does not.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13385.

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Date of creation: Sep 2007
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Handle: RePEc:nbr:nberwo:13385

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Find related papers by JEL classification:
C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data
D8 - Microeconomics - - Information, Knowledge, and Uncertainty
D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Investment, or Financing
E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Radha Iyengar & Jonathan Monten, 2008. "Is There an "Emboldenment" Effect? Evidence from the Insurgency in Iraq," NBER Working Papers 13839, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Draca, Mirko & Machin, Stephen & Witt, Robert, 2008. "Panic on the Streets of London: Police, Crime and the July 2005 Terror Attacks," IZA Discussion Papers 3410, Institute for the Study of Labor (IZA). [Downloadable!]
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  3. Letterie Wilko & Nilsen Øivind A. & Pfann Gerard, 2008. "Interrelated Factor Demand with Nonconvex Adjustment Costs: a Note," Research Memoranda 002, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization. [Downloadable!]
  4. Ruediger Bachmann & Ricardo J. Caballero & Eduardo Engel, 2008. "Aggregate Implications of Lumpy Investment: New Evidence and a DSGE Model," Cowles Foundation Discussion Papers 1566R, Cowles Foundation, Yale University. [Downloadable!]
  5. Eric Bond & James R. Tybout & Hâle Utar, 2008. "Credit Rationing, Risk Aversion and Industrial Evolution in Developing Countries," NBER Working Papers 14116, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Joao Miguel Ejarque & Oivind Anti Nilsen, 2008. "Identifying Adjustment Costs of Net and Gross Employment Changes," Economics Discussion Papers 660, University of Essex, Department of Economics. [Downloadable!]
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  7. Aubhik Khan & Julia K. Thomas, 2007. "Idiosyncratic shocks and the role of nonconvexities in plant and aggregate investment dynamics," Working Papers 07-24, Federal Reserve Bank of Philadelphia. [Downloadable!]
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  8. Nick Bloom, 2007. "Uncertainty and the Dynamics of R&D," CEP Discussion Papers dp0792, Centre for Economic Performance, LSE. [Downloadable!]
    Other versions:
  9. Catherine Tucker, 2008. "Social Interactions, Network Fluidity and Network Effects," Working Papers 08-30, NET Institute, revised Oct 2008. [Downloadable!]
  10. Timothy Dunne & Xiaoyi Mu, 2008. "Investment spikes and uncertainty in the petroleum refining industry," Working Paper 0805, Federal Reserve Bank of Cleveland. [Downloadable!]
  11. M. Eslava, J. Haltwanger, A. Kugler, M. Kugler, 2008. "Factor Adjustments After Deregulation: Panel Evidence from Colombian Plants," Working Papers eg0059, Wilfrid Laurier University, Department of Economics, revised 2008. [Downloadable!]
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