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The Risk-Premium Channel of Uncertainty: Implications for Unemployment and Inflation

Lukas Freund, Hanbaek Lee () and Pontus Rendahl

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

Abstract: This paper studies the role of macroeconomic uncertainty in a search-and-matching framework with risk-averse households. Heightened uncertainty about future productivity reduces current economic activity even in the absence of nominal rigidities. A risk-premium mechanism accounts for this result. As future asset prices become more volatile and covary more positively with aggregate consumption, the risk premium rises in the present. The associated downward pressure on current asset values lowers firm entry, making it harder for workers to find jobs and reduces supply. With nominal rigidities the recession is exacerbated, as a more uncertain future reinforces households’ precautionary behavior, which causes demand to contract. Counterfactual analyses using a calibrated model imply that unemployment would rise by less than half as much absent the risk-premium channel. The presence of this mechanism implies that uncertainty shocks are less deflationary than regular demand shocks, nor can they be fully neutralized by monetary policy.

Keywords: inflation; search frictions; Uncertainty; Unemployment (search for similar items in EconPapers)
JEL-codes: E21 E32 J64 (search for similar items in EconPapers)
Date: 2022-09-08
New Economics Papers: this item is included in nep-dge, nep-fdg, nep-lab, nep-mon and nep-upt
Note: lbf25
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Working Paper: The Risk-Premium Channel of Uncertainty: Implications for Unemployment and Inflation (2022) Downloads
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