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Policy Risk and the Business Cycle

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  • Benjamin Born
  • Johannes Pfeifer

Abstract

The argument that policy risk, i.e., uncertainty about monetary and fiscal policy, has been holding back the economic recovery in the U.S. during the Great Recession has a large popular appeal. We analyze the role of policy risk in explaining business cycle fluctuations by using an estimated New Keynesian model featuring policy risk as well as uncertainty about technology. We directly measure uncertainty from aggregate time series and find considerable evidence of time-varying policy risk in the data. However, the “pure uncertainty”-effect of policy risk is unlikely to play a major role in business cycle fluctuations. In the estimated model, output effects are relatively small because the aggregate policy risk shocks are i) too small and ii) not sufficiently amplified.

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  • Benjamin Born & Johannes Pfeifer, 2013. "Policy Risk and the Business Cycle," CESifo Working Paper Series 4336, CESifo.
  • Handle: RePEc:ces:ceswps:_4336
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    More about this item

    Keywords

    policy risk; uncertainty; aggregate fluctuations; particle filter; nominal rigidities;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General

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