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Uncertainty shocks are aggregate demand shocks

  • Sylvain Leduc
  • Zheng Liu

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.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2012-10.

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Date of creation: 2012
Handle: RePEc:fip:fedfwp:2012-10
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