We propose uncertainty shocks as a new shock that drives business cycles. First, we demonstrate that microeconomic uncertainty is robustly countercyclical, rising sharply during recessions, particularly during the Great Recession of [2007][2008][2009]. Second, we quantify the impact of timevarying uncertainty on the economy in a dynamic stochastic general equilibrium model with heterogeneous firms. We find that reasonably calibrated uncertainty shocks can explain drops and rebounds in GDP of around 3%. Moreover, we show that increased uncertainty alters the relative impact of government policies, making them initially less effective and then subsequently more effective.JEL classification: E3

We investigate the role of uncertainty in business cycles. First, we demonstrate that microeconomic uncertainty rises sharply during recessions, including during the Great Recession of 2007–2009. Second, we show that uncertainty shocks can generate drops in gross domestic product of around 2.5% in a dynamic stochastic general equilibrium model with heterogeneous firms. However, we also find that uncertainty shocks need to be supplemented by first‐moment shocks to fit consumption over the cycle. So our data and simulations suggest recessions are best modelled as being driven by shocks with a negative first moment and a positive second moment. Finally, we show that increased uncertainty can make first‐moment policies, like wage subsidies, temporarily less effective because firms become more cautious in responding to price changes.

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We propose uncertainty shocks as a new shock that drives business cycles. First, we demonstrate that microeconomic uncertainty is robustly countercyclical, rising sharply during recessions, particularly during the Great Recession of [2007][2008][2009]. Second, we quantify the impact of timevarying uncertainty on the economy in a dynamic stochastic general equilibrium model with heterogeneous firms. We find that reasonably calibrated uncertainty shocks can explain drops and rebounds in GDP of around 3%. Moreover, we show that increased uncertainty alters the relative impact of government policies, making them initially less effective and then subsequently more effective.JEL classification: E3

We study the effects of government intervention in the housing market on prices, quantities and welfare in a general equilibrium model with heterogeneous agents. We consider (i) the tax-deductibility of mortgage interest payments, and (ii) the exclusion of owner-occupied rents from taxation. We go beyond the existing literature and study both steady state effects as well as effects along the transition between steady states. When comparing stationary equilibria, we find that reducing asymmetries in the treatment of owner-occupied and rental housing in the tax code leads to welfare gains for all agents, as does the elimination of the mortgage interest deductibility. However, during the transition to the new steady-states, the welfare impacts are more varied. All agents benefit from the removal of the deduction of mortgage interest rates, due to general-equilibrium effects on prices and an increase in lump-sum transfers through higher government revenues. However, the introduction of taxes on imputed rents leads to significant welfare losses for all households that consume owner-occupied housing. This highlights the importance of focusing on the transition period for policy analysis.