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Uncertainty shocks in a model of effective demand

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Listed author(s):
  • Susanto Basu
  • Brent Bundick

Abstract

This paper examines the role of uncertainty shocks in a one-sector, representative-agent dynamic stochastic general equilibrium model. When prices are flexible, uncertainty shocks are not capable of producing business cycle comovements among key macro variables. With countercyclical markups through sticky prices, however, uncertainty shocks can generate fluctuations that are consistent with business cycles. Monetary policy usually plays a key role in offsetting the negative impact of uncertainty shocks. If the central bank is constrained by the zero lower bound, then monetary policy can no longer perform its usual stabilizing function and higher uncertainty has even more negative effects on the economy. Calibrating the size of uncertainty shocks using fluctuations in the VIX, the authors find that increased uncertainty about the future may indeed have played a significant role in worsening the Great Recession, which is consistent with statements by policymakers, economists, and the financial press.

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Paper provided by Federal Reserve Bank of Boston in its series Working Papers with number 12-15.

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Date of creation: 2012
Handle: RePEc:fip:fedbwp:12-15
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Keywords: Monetary policy ; Uncertainty ; Business cycles;

Other versions of this item:

Find related papers by JEL classification:
  • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
  • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Uncertainty Shocks in a Model of Effective Demand
    by Christian Zimmermann in NEP-DGE blog on 2011-10-17 16:46:15
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