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Macro uncertainty and unemployment risk

Joonseok Oh

No ECO 2019/02, Economics Working Papers from European University Institute

Abstract: This paper illustrates how households' heterogeneity is crucial for the propagation of uncertainty shocks. We empirically show that an uncertainty shock generates a drop in aggregate consumption, job finding rate, and inflation: the aggregate consumption response is mainly driven by the consumption response of the bottom 60% of the income distribution. A heterogeneous-agent New Keynesian model with search and matching frictions and Calvo pricing rationalizes our findings. Uncertainty shocks induce households' precautionary saving and firms' precautionary pricing behaviors, triggering a fall in aggregate demand and supply. The two precautionary behaviors increase the unemployment risk of the imperfectly insured, who strengthen their precautionary saving behavior. When the feedback loop between unemployment risk and precautionary saving is strong enough, a rise in uncertainty leads to a decrease in inflation. Contrary to standard representative agent New Keynesian models, our model qualitatively and quantitatively matches the empirical evidence on uncertainty shock propagation.

Keywords: Uncertainty; Inflation; Unemployment risk; Precautionary savings (search for similar items in EconPapers)
JEL-codes: E12 E31 E32 J64 (search for similar items in EconPapers)
Date: 2019
New Economics Papers: this item is included in nep-dge, nep-lab, nep-mac and nep-ore
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Working Paper: Macro Uncertainty and Unemployment Risk (2020) Downloads
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