Uncertainty and Monetary Policy in the US: A Journey into Non-Linear Territory

This paper estimates a non-linear Interacted VAR model to assess whether the real effects of monetary policy shocks are milder during times of high uncertainty. In a novel way, uncertainty, i.e., the conditioning indicator discriminating “high†and “low†uncertainty states, is modeled endogenously in the VAR and is found to reduce after an expansionary shock. Generalized Impulse Response Functions à la Koop, Pesaran and Potter (1996) suggest that monetary policy shocks are significantly less powerful during uncertain times, with the peak reactions of a battery of real variables being about two-thirds milder than those during tranquil times. Among the theoretical explanations proposed by the literature, real option effects and precautionary savings appear the ones supported by our results.