Unexpected Effects: Uncertainty, Unemployment, and Inflation

Lukas Freund and Pontus Rendahl

Cambridge Working Papers in Economics from Faculty of Economics, University of Cambridge

Abstract: This paper studies the role of uncertainty in a search-and-matching framework with risk-averse households. A mean-preserving spread to future productivity contracts current economic activity even in the absence of nominal rigidities, although the effect is reinforced by the presence of the latter. That is, uncertainty shocks carry both contractionary demand- and supply effects. The reason is that a more uncertain future increases the precautionary behavior of households, which reduces interest rates and contracts demand. At the same time, as future asset prices becomes more volatile and positively covary with aggregate consumption, households demand a larger risk premium, which puts negative pressure on current asset values and thereby contracts supply. Thus, in comparison to a pure negative demand shock, an uncertainty shock puts less deflationary pressure on the economy and, as a result, renders a flatter Phillips curve.

Keywords: COVID-19; Uncertainty; unemployment; inflation; search frictions (search for similar items in EconPapers)
JEL-codes: E21 E32 J64 (search for similar items in EconPapers)
Date: 2020-05-04
New Economics Papers: this item is included in nep-dge, nep-lab, nep-mac and nep-upt
Note: rpk22, lbf25
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Working Paper: Unexpected Effects: Uncertainty, Unemployment, and Inflation (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:cam:camdae:2035

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