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Uncertainty shocks are aggregate demand shocks

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  • Sylvain Leduc
  • Zheng Liu

Abstract

We study the macroeconomic effects of uncertainty shocks in a DSGE model with labor search frictions and sticky prices. In contrast to a real business cycle model, the model with search frictions implies that uncertainty shocks reduce potential output, because a job match represents a long-term employment relation and heightened uncertainty reduces the value of a match. In the sticky-price equilibrium, an uncertainty shock--regardless of its source--consistently acts like an aggregate demand shock because it raises unemployment and lowers inflation. We present empirical evidence--based on a vector autoregression model and using a few alternative measures of uncertainty--that supports the theory's prediction that uncertainty shocks are aggregate demand shocks.

Suggested Citation

  • Sylvain Leduc & Zheng Liu, 2012. "Uncertainty shocks are aggregate demand shocks," Working Paper Series 2012-10, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfwp:2012-10
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    More about this item

    Keywords

    Uncertainty; Inflation (Finance); 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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