Working Paper

Uncertainty shocks are aggregate demand shocks

Abstract: We study the macroeconomic effects of uncertainty shocks in a DSGE model with labor search frictions and sticky prices. In contrast to a real business cycle model, the model with search frictions implies that uncertainty shocks reduce potential output, because a job match represents a long-term employment relation and heightened uncertainty reduces the value of a match. In the sticky-price equilibrium, an uncertainty shock--regardless of its source--consistently acts like an aggregate demand shock because it raises unemployment and lowers inflation. We present empirical evidence--based on a vector autoregression model and using a few alternative measures of uncertainty--that supports the theory's prediction that uncertainty shocks are aggregate demand shocks.

Keywords: Uncertainty; Inflation (Finance); Unemployment;

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Paper Series

Publication Date: 2012

Number: 2012-10