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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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File URL: https://economicdynamics.org/meetpapers/2013/paper_270.pdf
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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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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. Baker, Scott R. & Bloom, Nicholas & Davis, Steven J, 2015. "Measuring Economic Policy Uncertainty," CEPR Discussion Papers 10900, C.E.P.R. Discussion Papers.
  2. Susanto Basu & Brent Bundick, 2012. "Uncertainty shocks in a model of effective demand," Working Papers 12-15, Federal Reserve Bank of Boston.
  3. Steffen Elstner & Eric Sims & Ruediger Bachmann, 2010. "Uncertainty and Economic Activity: Evidence from Business Survey Data," 2010 Meeting Papers 614, Society for Economic Dynamics.
  4. Jesus Fernandez-Villaverde & Pablo Guerron-Quintana & Keith Kuester & Juan Rubio-Ramirez, 2011. "Fiscal Volatility Shocks and Economic Activity," PIER Working Paper Archive 11-022, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  5. Xavier Gabaix, 2012. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance," The Quarterly Journal of Economics, Oxford University Press, vol. 127(2), pages 645-700.
  6. Sylvain Leduc & Keith Sill, 2010. "Expectations and economic fluctuations: an analysis using survey data," Working Papers 10-6, Federal Reserve Bank of Philadelphia.
  7. Leahy, John V & Whited, Toni M, 1996. "The Effect of Uncertainty on Investment: Some Stylized Facts," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(1), pages 64-83, February.
  8. Nicholas Bloom & Max Floetotto & Nir Jaimovich & Itay Saporta-Eksten & Stephen Terry, 2013. "Really uncertain business cycles," LSE Research Online Documents on Economics 51526, London School of Economics and Political Science, LSE Library.
  9. 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, revised 01 May 2003.
  10. P. Diamond, 1980. "Aggregate Demand Management in Search Equilibrium," Working papers 268, Massachusetts Institute of Technology (MIT), Department of Economics.
  11. Alan J. Auerbach & Yuriy Gorodnichenko, 2010. "Measuring the Output Responses to Fiscal Policy," NBER Working Papers 16311, National Bureau of Economic Research, Inc.
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