When Does Uncertainty Become Expansionary? The Role of Composition and State Dependence

When does uncertainty become expansionary? While the empirical literature generally concludes that uncertainty depresses economic activity, recent theoretical contributions suggest that some forms of uncertainty may instead stimulate investment and output. This paper argues that the macroeconomic effects of uncertainty depend jointly on its composition and the prevailing uncertainty regime. Using sixteen U.S. uncertainty indicators over the period 1990–2024, we construct two orthogonal latent factors through principal component analysis. The first captures the overall level of uncertainty, whereas the second distinguishes financial from non-financial uncertainty. An independent VARIMAX rotation validates this interpretation. We then estimate state-dependent local projections to examine how different uncertainty shocks affect industrial production and employment across low-, moderate-, and high-uncertainty regimes. We find that financial uncertainty shocks generate the conventional contractionary effects. In contrast, non-financial uncertainty shocks significantly increase economic activity when aggregate uncertainty is moderate or high, while they have no significant effect during low-uncertainty periods. These findings suggest that the composition of uncertainty is a key determinant of its macroeconomic consequences and provide new aggregate evidence supporting recent theories predicting expansionary effects of non-financial uncertainty.