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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," Discussion Paper Series, School of Economics and Finance 201710, School of Economics and Finance, University of St Andrews, revised 25 May 2017.
  • Handle: RePEc:san:wpecon:1710
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    References listed on IDEAS

    as
    1. Susanto Basu & Brent Bundick, 2017. "Uncertainty Shocks in a Model of Effective Demand," Econometrica, Econometric Society, vol. 85, pages 937-958, May.
    2. Haroon Mumtaz & Francesco Zanetti, 2013. "The Impact of the Volatility of Monetary Policy Shocks," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(4), pages 535-558, June.
    3. Alexander W. Richter & Nathaniel A. Throckmorton, 2017. "A New Way to Quantify the Effect of Uncertainty," Working Papers 1705, Federal Reserve Bank of Dallas.
    4. 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.
    5. 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.
    6. 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.
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    Citations

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    Cited by:

    1. Freund, Lukas & Rendahl, Pontus, 2020. "Unexpected Effects: Uncertainty, Unemployment, and Inflation," CEPR Discussion Papers 14690, C.E.P.R. Discussion Papers.
    2. Grzegorz Długoszek, 2018. "Macroeconomic Effects of Financial Uncertainty," 2018 Meeting Papers 1128, Society for Economic Dynamics.
    3. Bonciani, Dario & Oh, Joonseok Jason, 2019. "The long-run effects of uncertainty shocks," Bank of England working papers 802, Bank of England.
    4. Giovanni Pellegrino & Efrem Castelnuovo & Giovanni Caggiano, 2020. "Uncertainty and Monetary Policy during Extreme Events," CESifo Working Paper Series 8561, CESifo.
    5. OH, Joonseok; ROGANTINI PICCO, Anna, 2019. "Macro uncertainty and unemployment risk," Economics Working Papers ECO 2019/02, European University Institute.
    6. Oliver de Groot & Alexander W. Richter & Nathaniel A. Throckmorton, 2018. "Valuation Risk Revalued," CDMA Working Paper Series 201803, Centre for Dynamic Macroeconomic Analysis.
    7. Giovanni Caggiano & Efrem Castelnuovo & Juan Manuel Figueres, 2020. "Economic Policy Uncertainty Spillovers in Booms and Busts," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 82(1), pages 125-155, February.
    8. Gareth Lui-Evans & Shalini Mitra, 2019. "Informality and Bank Stability," Working Papers 201903, University of Liverpool, Department of Economics.
    9. Alexander W. Richter & Nathaniel A. Throckmorton, 2017. "A New Way to Quantify the Effect of Uncertainty," Working Papers 1705, Federal Reserve Bank of Dallas.
    10. Ying Tung Chan, 2019. "The Environmental Impacts and Optimal Environmental Policies of Macroeconomic Uncertainty Shocks: A Dynamic Model Approach," Sustainability, MDPI, Open Access Journal, vol. 11(18), pages 1-26, September.

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    More about this item

    Keywords

    Stochastic Volatility; Epstein-Zin Preferences; Uncertainty; Economic Activity;
    All these keywords.

    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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