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The propagation of uncertainty shocks: Rotemberg vs. Calvo

Joonseok Oh

No ECO 2019/01, Economics Working Papers from European University Institute

Abstract: This paper studies the effects of uncertainty shocks on economic activity, focusing on inflation. Using a VAR, I show that increased uncertainty has negative demand effects, reducing GDP and prices. I then consider standard New Keynesian models with Rotemberg-type and Calvo-type price rigidities. Despite the belief that the two schemes are equivalent, I show that they generate different dynamics in response to uncertainty shocks. In the Rotemberg model, uncertainty shocks decrease output and inflation, in line with the empirical results. By contrast, in the Calvo model, uncertainty shocks decrease output but raise inflation because of firms' precautionary pricing motive.

Keywords: uncertainty shocks; inflation; Rotemberg pricing; Calvo pricing (search for similar items in EconPapers)
JEL-codes: C68 E31 E32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2019
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