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Uncertainty shocks are aggregate demand shocks

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  • Leduc, Sylvain
  • Liu, Zheng

Abstract

Search frictions in the labor market give rise to a new option-value channel through which uncertainty affects aggregate economic activity, and the effects of which are reinforced by the presence of nominal rigidities. With these features, an increase in uncertainty resembles an aggregate demand shock because it increases unemployment and lowers inflation. Using a new empirical measure of uncertainty based on the Michigan survey and a VAR model, we show that these theoretical patterns are consistent with US data. Using a calibrated DSGE model, we show that combining search frictions and nominal rigidities can match the qualitative VAR pattern and account for about 70percent of the empirical increase in unemployment following an uncertainty shock.

Suggested Citation

  • Leduc, Sylvain & Liu, Zheng, 2016. "Uncertainty shocks are aggregate demand shocks," Journal of Monetary Economics, Elsevier, vol. 82(C), pages 20-35.
  • Handle: RePEc:eee:moneco:v:82:y:2016:i:c:p:20-35
    DOI: 10.1016/j.jmoneco.2016.07.002
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    More about this item

    Keywords

    E21; E32; J64; Uncertainty; Aggregate demand; Labor search frictions; Option-value channel; Unemployment;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search

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