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Uncertainty Shocks Are Aggregate Demand Shocks

  • Zheng Liu

    (Federal Reserve Bank of San Francisco)

  • Sylvain Leduc

    (Federal Reserve Bank of San Francisco)

We present empirical evidence and a theoretical argument that uncertainty shocks act like a negative aggregate demand shock, which raises unemployment and lowers inflation. We measure uncertainty using survey data from the United States and the United Kingdom. We estimate the macroeconomic effects of uncertainty shocks in a vector autoregression (VAR) model, exploiting the relative timing of the surveys and macroeconomic data releases for identification. Our estimation reveals that uncertainty shocks accounted for at least one percentage point increases in unemployment in the Great Recession and recovery, but did not contribute much to the 1981-82 recession. We present a DSGE model to show that, to understand the observed macroeconomic effects of uncertainty shocks, it is essential to have both labor search frictions and nominal rigidities.

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Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 270.

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Date of creation: 2013
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Handle: RePEc:red:sed013:270
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  1. Jae Sim & Egon Zakrajsek & Simon Gilchrist, 2010. "Uncertainty, Financial Frictions, and Investment Dynamics," 2010 Meeting Papers 1285, Society for Economic Dynamics.
  2. Jesus Fernandez-Villaverde & Pablo Guerron-Quintana & Keith Kuester & Juan Rubio-Ramirez, 2011. "Fiscal volatility shocks and economic activity," Working Papers 11-32, Federal Reserve Bank of Philadelphia.
  3. Xavier Gabaix, 2008. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance," NBER Working Papers 13724, National Bureau of Economic Research, Inc.
  4. Sylvain Leduc & Keith Sill, 2010. "Expectations and economic fluctuations: an analysis using survey data," Working Paper Series 2010-09, Federal Reserve Bank of San Francisco.
  5. Mortensen, Dale T & Pissarides, Christopher A, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 61(3), pages 397-415, July.
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  8. Eric R. Sims, 2012. "Uncertainty and Economic Activity: Evidence from Business Survey Data," Working Papers 014, University of Notre Dame, Department of Economics, revised Jun 2012.
  9. Susanto Basu & Brent Bundick, 2012. "Uncertainty shocks in a model of effective demand," Working Papers 12-15, Federal Reserve Bank of Boston.
  10. Nicholas Bloom & Max Floetotto & Nir Jaimovich & Itay Saporta-Eksten & Stephen J. Terry, 2014. "Really Uncertain Business Cycles," Working Papers 14-18, Center for Economic Studies, U.S. Census Bureau.
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  15. Francois Gourio, 2009. "Disaster risk and business cycles," 2009 Meeting Papers 1176, Society for Economic Dynamics.
  16. Alan J. Auerbach & Yuriy Gorodnichenko, 2010. "Measuring the Output Responses to Fiscal Policy," NBER Working Papers 16311, National Bureau of Economic Research, Inc.
  17. Francois Gourio, 2012. "Credit risk and disaster risk," Working Paper Series WP-2012-07, Federal Reserve Bank of Chicago.
  18. Basu, Susanto & Fernald, John G, 1997. "Returns to Scale in U.S. Production: Estimates and Implications," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 249-83, April.
  19. Diamond, Peter A, 1982. "Aggregate Demand Management in Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 881-94, October.
  20. Ruediger Bachmann & Giuseppe Moscarini, 2011. "Business Cycles and Endogenous Uncertainty," 2011 Meeting Papers 36, Society for Economic Dynamics.
  21. Sylvain Leduc & Keith Sill & Tom Stark, 2002. "Self-fulfilling expectations and the inflation of the 1970s: evidence from the Livingston Survey," Working Papers 02-13, Federal Reserve Bank of Philadelphia.
  22. Christopher A. Sims & Tao Zha, 1996. "Bayesian methods for dynamic multivariate models," Working Paper 96-13, Federal Reserve Bank of Atlanta.
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