TY  - JOUR
AU  - Basu, Susanto
AU  - Bundick, Brent
TI  - Uncertainty Shocks in a Model of Effective Demand
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 18420
PY  - 2012
Y2  - September 2012
DO  - 10.3386/w18420
UR  - http://www.nber.org/papers/w18420
L1  - http://www.nber.org/papers/w18420.pdf
N1  - Author contact info:
Susanto Basu
Department of Economics
Boston College
140 Commonwealth Avenue
Chestnut Hill, MA 02467
Tel: 617/552-2182
Fax: 617/552-2308
E-Mail: susanto.basu@bc.edu

Brent Bundick
Federal Reserve Bank of Kansas City
Economic Research Department
1 Memorial Drive
Kansas City, MO 64198
E-Mail: brent.bundick@kc.frb.org
AB  - Can increased uncertainty about the future cause a contraction in output and its components? An identified uncertainty shock in the data causes significant declines in output, consumption, investment, and hours worked. Standard general-equilibrium models with flexible prices cannot reproduce this comovement. However, uncertainty shocks can easily generate comovement with countercyclical markups through sticky prices. Monetary policy plays a key role in offsetting the negative impact of uncertainty shocks during normal times. Higher uncertainty has even more negative effects if monetary policy can no longer perform its usual stabilizing function because of the zero lower bound. We calibrate our uncertainty shock process using fluctuations in implied stock market volatility, and show that the model with nominal price rigidity is consistent with empirical evidence from a structural vector autoregression. We argue that increased uncertainty about the future likely played a role in worsening the Great Recession. The economic mechanism we identify applies to a large set of shocks that change expectations of the future without changing current fundamentals.
ER  -