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Federal Reserve Bank of San Francisco
Working Paper Series
Uncertainty shocks are aggregate demand shocks
Sylvain Leduc
Zheng Liu
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.


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Sylvain Leduc & Zheng Liu, Uncertainty shocks are aggregate demand shocks, Federal Reserve Bank of San Francisco, Working Paper Series 2012-10, 2012.
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Keywords: Uncertainty ; Inflation (Finance) ; Unemployment
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