Uncertainty and Business Cycles: Exogenous Impulse or Endogenous Response?

Sydney C. Ludvigson, Sai Ma, Serena Ng

NBER Working Paper No. 21803
Issued in December 2015, Revised in January 2019
NBER Program(s):Asset Pricing, Economic Fluctuations and Growth, Monetary Economics

Uncertainty about the future rises in recessions. But is uncertainty a source of business cycles or an endogenous response to them, and does the type of uncertainty matter? We propose a novel SVAR identification strategy to address these questions. Rather than imposing a priori restrictions on the structural parameters of the SVAR, we use the data to motivate inequality constraints on the structural shocks at specific dates that unusual events are known to have occurred ex post. We then use the correlation of the shocks with external variables to tighten the identified set. This leads to a set of solutions for inference. We find that sharply higher macroeconomic uncertainty in recessions is often an endogenous response to output shocks, while uncertainty about financial markets is a likely source of output fluctuations. But the findings also suggest that macroeconomic uncertainty plays an important role in recessions, by substantially amplifying downturns caused by other shocks. Together, the results suggest that second moment shocks have first order consequences, but that not all uncertainties are alike.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w21803

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