Uncertainty shocks in a model of effective demand

Susanto Basu and Brent Bundick

No 12-15, Working Papers from Federal Reserve Bank of Boston

Abstract: This paper examines the role of uncertainty shocks in a one-sector, representative-agent dynamic stochastic general equilibrium model. When prices are flexible, uncertainty shocks are not capable of producing business cycle comovements among key macro variables. With countercyclical markups through sticky prices, however, uncertainty shocks can generate fluctuations that are consistent with business cycles. Monetary policy usually plays a key role in offsetting the negative impact of uncertainty shocks. If the central bank is constrained by the zero lower bound, then monetary policy can no longer perform its usual stabilizing function and higher uncertainty has even more negative effects on the economy. Calibrating the size of uncertainty shocks using fluctuations in the VIX, the authors find that increased uncertainty about the future may indeed have played a significant role in worsening the Great Recession, which is consistent with statements by policymakers, economists, and the financial press.

Keywords: Monetary policy; Uncertainty; Business cycles (search for similar items in EconPapers)
Date: 2012
New Economics Papers: this item is included in nep-dge and nep-mac
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Citations: View citations in EconPapers (126)

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Related works:
Journal Article: Uncertainty Shocks in a Model of Effective Demand (2017)
Working Paper: Uncertainty Shocks in a Model of Effective Demand (2015)
Working Paper: Uncertainty shocks in a model of effective demand (2014)
Working Paper: Uncertainty Shocks in a Model of Effective Demand (2012)
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