Uncertainty Shocks in a Model of Effective Demand

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. This paper examines the role of uncertainty shocks in a one-sector, representative-agent dynamic stochastic general equilibrium model. When prices are flexible, uncertainty shocks are not capable of producing business cycle comovements among key macro variables. With countercyclical markups through sticky prices, however, uncertainty shocks can generate fluctuations that are consistent with business cycles. Monetary policy usually plays a key role in offsetting the negative impact of uncertainty shocks. If the central bank is constrained by the zero lower bound, then monetary policy can no longer perform its usual stabilizing function and higher uncertainty has even more negative effects on the economy. Calibrating the size of uncertainty shocks using fluctuations in the VIX, the authors find that increased uncertainty about the future may indeed have played a significant role in worsening the Great Recession, which is consistent with statements by policymakers, economists, and the financial press. JEL Classifications: E32, E52 Terms of use: Documents in EconStor may

Uncertainty, Financial Frictions, and Nominal Rigidities: A Quantitative Investigation

“…In our baseline calibration—and differently from Basu and Bundick () —the macro‐uncertainty shock does not generate an impact increase in “precautionary labor supply,” since consumption does not enter the labor supply schedule. We explore the role of different preferences below.…”

“…The key insight (as noted by Fernandez‐Villaverde et al. , Born and Pfeifer , Basu and Bundick ) is that under price stickiness output is demand determined (i.e., firms must satisfy whatever output is demanded at a given price), so that the reduction in consumption acts to reduce aggregate demand. Hence, demand for both labor and capital falls, and investment falls too.…”

“…As a number of earlier papers have documented, price stickiness is crucial for the propagation of uncertainty shocks: it generates comovement between consumption and investment as well as amplifying the impact of the shocks (Fernandez‐Villaverde et al. , Born and Pfeifer , Basu and Bundick )). Figure shows this observation as it compares the IRFs from the baseline calibration (dark circles) with the IRFs from a flexible price version of the model (light squares) obtained by setting the price stickiness parameter as .…”

“…Fernandez‐Villaverde et al. () and Basu and Bundick () also show that, when the monetary policy is constrained by the zero lower bound, the conditional impact of uncertainty shocks can be sizable.…”

“…For uncertainty about aggregate shocks, see Justiniano and Primiceri (), Fernandez‐Villaverde and Rubio‐Ramirez (), Fernandez‐Villaverde et al. (, ), Basu and Bundick (), Born and Pfeifer (), Gourio (), and Leduc and Liu (). For uncertainty about idiosyncratic shocks, see Dorofeenko, Lee, and Salyer (), Gilchrist, Sim, and Zakrajsek (), Arellano, Bai, and Kehoe (), Christiano, Motto, and Rostagno ().…”