Uncertainty Shocks and Business Cycles in Brazil: A DSGE Approach

Abstract

In this paper we analyze the impact of uncertainty shocks on the Brazilian economy. We use a general equilibrium model in such a way that the transmission channels of the shocks could be identified and we solve the model using a third order approximation for the policy functions since lower order approximations are not able to capture the effects of volatility shocks. Examining the channels through which shocks of uncertainty on TFP and interest rates may affect Brazilian economy, the impulse-response functions suggest that an increase in domestic and external volatility usually leads to a drop in consumption, investment, and output, and an increase in labor supply and external debt. Through the variance decomposition uncertainty shocks are relevant to explain the dynamics of economic activity in Brazil. Additionally we perform a robustness analysis and showed that the results are not maintained in response to different calibrations.