Abstract
This article investigates if the impact of uncertainty shocks on the U.S. economy has changed over time. To this end, we develop an extended factor augmented vector autoregression (VAR) model that simultaneously allows the estimation of a measure of uncertainty and its time-varying impact on a range of variables. We find that the impact of uncertainty shocks on real activity and financial variables has declined systematically over time. In contrast, the response of inflation and the short-term interest rate to this shock has remained fairly stable. Simulations from a nonlinear dynamic stochastic general equilibrium (DSGE) model suggest that these empirical results are consistent with an increase in the monetary authorities’ antiinflation stance and a “flattening” of the Phillips curve. Supplementary materials for this article are available online.
Highlights
The recent ...nancial crisis and ensuing recession have led to a renewed interest in the possible relationship between economic uncertainty and macroeconomic variables
Our results suggest that the impact of uncertainty shocks on measures of real activity, asset prices and indicators of ...nancial conditions has declined systematically over time
The simulations presented above indicate that the estimated changes in the response of real activity and credit spreads to uncertainty shocks can be consistent with a shift in Taylor rule parameters, wage/price rigidity and easing of ...nancial frictions
Summary
The recent ...nancial crisis and ensuing recession have led to a renewed interest in the possible relationship between economic uncertainty and macroeconomic variables. An increase in the magnitude of the Taylor rule in‡ation coe¢ cient implies that in‡ation responds less to an increase in uncertainty as agents become less concerned about expected in‡ation This in-turn allows the monetary authority to reduce interest rates more quickly than otherwise possible to tackle the adverse real activity e¤ects of the uncertainty shock and reduces the magnitude of the decline in output and asset prices. The simultaneous increase in price stickiness and decrease in the degree of indexation in the model increases the positive response of in‡ation to the uncertainty shock (as agents hedge against being locked into a contract with an unfavourable price) and dampens the initial impact of a rise in the Fed’s anti-in‡ation stance This implies that the in‡ation and interest rate response remains fairly constant at short and medium horizons.
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