Complementarity and Macroeconomic Uncertainty

Macroeconomic uncertainty—the conditional volatility of the unforecastable component of a future value of a time series—shows considerable variation in the data. A typical assumption in business cycle models is that production is Cobb-Douglas. Under that assumption, this paper shows there is usually little, if any, endogenous variation in output uncertainty, and first moment shocks have similar effects in all states of the economy. When the model departs from Cobb-Douglas production and assumes capital and labor are gross complements, first-moment shocks have state-dependent effects and can cause meaningful variation in uncertainty compared to the data. Estimating several variants of a nonlinear real business cycle model reveals the data strongly prefers a model with high complementarity between capital and labor inputs.