Time-varying effect of uncertainty shocks on unemployment

Abstract

We examine the dynamic effects of uncertainty shocks on unemployment during recessions in the US. We estimate a Bayesian time-varying parameter structural vector autoregression. We analyze how the impact of uncertainty shocks on U.S. unemployment changes over time. We find that uncertainty shocks have both higher unit impact and higher total effect on unemployment during the Great Recession compared to those of previous recessions. Different characteristics of the Great Recession amplify the effect of uncertainty on unemployment. Two channels distinguish the Great Recession from other recessions: the federal funds rate hitting the zero lower bound and financial frictions. We find that these factors are significant determinants of the time-varying relationship between unemployment and uncertainty. Robustness analyses with alternative measures of uncertainty and alternative empirical specifications validate the results of the paper. • Uncertainty significantly affects US unemployment. • The effect of uncertainty on unemployment varies over time. • The effect is substantially higher during the Great Recession. • The zero lower bound and financial frictions are among the causes of time-varying effect.