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A New Way to Quantify the Effect of Uncertainty

Author

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  • Alexander Richter

    (Federal Reserve Bank of Dallas)

  • Nathaniel Throckmorton

    (College of William & Mary)

Abstract

This paper develops a new way to quantify the effect of uncertainty and other higher-order moments. First, we estimate a nonlinear model using Bayesian methods with data on uncertainty, in addition to common macro time series. This key step disciplines the model and allows us to generate data-driven policy functions for any higher-order moment. Second, we use the Euler equation to analytically decompose consumption into several terms--expected consumption, the ex-ante real interest rate and the ex-ante variance and skewness of future consumption, technology growth, and inflation--and then use the policy functions to filter the data and generate a time series for the effect of each term. We apply our method to a familiar New Keynesian model with a zero lower bound constraint on the nominal interest rate and two stochastic volatility shocks, but it is adaptable to any dynamic model. Over a 1-quarter horizon, uncertainty has a very small effect on consumption, similar to the volatility shocks in our model. Over horizons that remove the influence of expected consumption, the effect of uncertainty is an order of magnitude larger. Other higher-order moments have much smaller effects.

Suggested Citation

  • Alexander Richter & Nathaniel Throckmorton, 2018. "A New Way to Quantify the Effect of Uncertainty," 2018 Meeting Papers 565, Society for Economic Dynamics.
  • Handle: RePEc:red:sed018:565
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    File URL: https://economicdynamics.org/meetpapers/2018/paper_565.pdf
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    References listed on IDEAS

    as
    1. Oliver de Groot & Alexander W. Richter & Nathaniel A. Throckmorton, 2018. "Uncertainty Shocks in a Model of Effective Demand: Comment," Econometrica, Econometric Society, vol. 86(4), pages 1513-1526, July.
    2. repec:wly:econjl:v:128:y:2018:i:611:p:1730-1757 is not listed on IDEAS
    3. Alexander Richter & Nathaniel Throckmorton & Todd Walker, 2014. "Accuracy, Speed and Robustness of Policy Function Iteration," Computational Economics, Springer;Society for Computational Economics, vol. 44(4), pages 445-476, December.
    4. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    5. Pablo D. Fajgelbaum & Edouard Schaal & Mathieu Taschereau-Dumouchel, 2017. "Uncertainty Traps," The Quarterly Journal of Economics, Oxford University Press, vol. 132(4), pages 1641-1692.
    6. Straub, Ludwig & Ulbricht, Robert, 2015. "Endogenous Uncertainty and Credit Crunches," TSE Working Papers 15-604, Toulouse School of Economics (TSE), revised Dec 2017.
    7. Edward P. Herbst & Frank Schorfheide, 2016. "Bayesian Estimation of DSGE Models," Economics Books, Princeton University Press, edition 1, number 10612, December.
    8. Zhiguo He & Arvind Krishnamurthy, 2012. "A macroeconomic framework for quantifying systemic risk," Working Paper Research 233, National Bank of Belgium.
    9. William B. Peterman, 2016. "Reconciling Micro And Macro Estimates Of The Frisch Labor Supply Elasticity," Economic Inquiry, Western Economic Association International, vol. 54(1), pages 100-120, January.
    10. Michael Plante & Alexander W. Richter & Nathaniel A. Throckmorton, 2018. "The Zero Lower Bound and Endogenous Uncertainty," Economic Journal, Royal Economic Society, vol. 128(611), pages 1730-1757, June.
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    Cited by:

    1. Oliver de Groot & Alexander W. Richter & Nathaniel A. Throckmorton, 2018. "Uncertainty Shocks in a Model of Effective Demand: Comment," Econometrica, Econometric Society, vol. 86(4), pages 1513-1526, July.

    More about this item

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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