Uncertainty shocks are aggregate demand shocks |
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| Institution: | 1. Bank of Estonia, Estonia pst 13, 15095 Tallinn, Estonia;2. University of Hamburg, Welckerstr. 8, 20354 Hamburg, Germany;1. Monash University, Australia;2. University of Melbourne, Australia;3. University of Padova, Italy;4. Bank of Finland, Finland;5. University of Verona, Italy;1. Department of Economics, Texas Tech University, P.O. Box 41014, Lubbock, TX 79409-1014 USA;2. Department of Economics, The George Washington University, 2115 G Street, NW Monroe Hall 340, Washington, DC 20052, USA |
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| Abstract: | Search frictions in the labor market give rise to a new option-value channel through which uncertainty affects aggregate economic activity, and the effects of which are reinforced by the presence of nominal rigidities. With these features, an increase in uncertainty resembles an aggregate demand shock because it increases unemployment and lowers inflation. Using a new empirical measure of uncertainty based on the Michigan survey and a VAR model, we show that these theoretical patterns are consistent with US data. Using a calibrated DSGE model, we show that combining search frictions and nominal rigidities can match the qualitative VAR pattern and account for about 70 percent of the empirical increase in unemployment following an uncertainty shock. |
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| Keywords: | Uncertainty Aggregate demand Labor search frictions Option-value channel Unemployment |
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