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Uncertainty Shocks in a Model of Effective Demand: Comment

Author

Listed:
  • Oliver de Groot

    () (University of St Andrews)

  • Alexander W. Richter

    () (Federal Reserve Bank of Dallas)

  • Nathaniel A. Throckmorton

    () (College of William & Mary)

Abstract

Basu and Bundick (2017) show a second moment intertemporal preference shock creates meaningful declines in output in a sticky price model with Epstein and Zin (1991) preferences. The result, however, rests on the way they model the shock. If a preference shock is included in Epstein-Zin preferences, the distributional weights on current and future utility must sum to 1, otherwise it creates an asymptote in the response to the shock with unit intertemporal elasticity of substitution. When we change the preferences so the weights sum to 1, the asymptote disappears as well as their main results—uncertainty shocks generate small increases in output and comovement with consumption and investment that is at odds with the data. We examine three changes to the model—recalibration, a risk-premium shock, and a disaster risk-type shock—to try and restore their results, but in all three cases the model is unable to match VAR evidence.

Suggested Citation

  • Oliver de Groot & Alexander W. Richter & Nathaniel A. Throckmorton, 2017. "Uncertainty Shocks in a Model of Effective Demand: Comment," CDMA Working Paper Series 201703, Centre for Dynamic Macroeconomic Analysis, revised 25 May 2017.
  • Handle: RePEc:san:cdmawp:1703
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    File URL: http://www.st-andrews.ac.uk/~wwwecon/repecfiles/2/1703.pdf
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    References listed on IDEAS

    as
    1. Fernández-Villaverde, Jesús & Gordon, Grey & Guerrón-Quintana, Pablo & Rubio-Ramírez, Juan F., 2015. "Nonlinear adventures at the zero lower bound," Journal of Economic Dynamics and Control, Elsevier, vol. 57(C), pages 182-204.
    2. Susanto Basu & Brent Bundick, 2017. "Uncertainty Shocks in a Model of Effective Demand," Econometrica, Econometric Society, vol. 85, pages 937-958, May.
    3. Richter, Alexander W. & Throckmorton, Nathaniel, 2017. "A New Way to Quantify the Effect of Uncertainty," Working Papers 1705, Federal Reserve Bank of Dallas, revised 23 Feb 2018.
    4. Ravi Bansal & Amir Yaron, 2004. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," Journal of Finance, American Finance Association, vol. 59(4), pages 1481-1509, August.
    5. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-286, April.
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    Cited by:

    1. Giovanni Caggiano & Efrem Castelnuovo & Juan Manuel Figueres, 2017. "Economic Policy Uncertainty Spillovers in Booms and Busts," Melbourne Institute Working Paper Series wp2017n13, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
    2. Richter, Alexander W. & Throckmorton, Nathaniel, 2017. "A New Way to Quantify the Effect of Uncertainty," Working Papers 1705, Federal Reserve Bank of Dallas, revised 23 Feb 2018.

    More about this item

    Keywords

    Stochastic Volatility; Epstein-Zin Preferences; Uncertainty; Economic Activity;

    JEL classification:

    • 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

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