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Uncertainty and Business Cycles: Exogenous Impulse or Endogenous Response

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  • Sydney Ludvigson

    (New York University)

Abstract

Uncertainty about the future rises in recessions. But is uncertainty a source of business cycle fluctuations or an endogenous response to them, and does the type of uncertainty matter? Answer: we find that sharply higher uncertainty about real economic activity in recessions is fully an endogenous response to other shocks that cause business cycle fluctuations, while uncertainty about financial markets is a likely source of the fluctuations. Financial market uncertainty has quantitatively large negative consequences for several measures of real activity including employment, production, and orders. Such are the main conclusions drawn from estimation of three-variable structural vector autoregressions. To establish causal effects, we propose an iterative projection IV (IPIV) approach to construct external instruments that are valid under credible interpretations of the structural shocks.

Suggested Citation

  • Sydney Ludvigson, 2016. "Uncertainty and Business Cycles: Exogenous Impulse or Endogenous Response," 2016 Meeting Papers 183, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:183
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