Abstract
We consider the effects of uncertainty shocks in a nonlinear VAR that allows uncertainty to have amplification effects. When uncertainty is relatively low, fluctuations in uncertainty have small, linear effects. In periods of high uncertainty, the effect of a further increase in uncertainty is magnified. We find that uncertainty shocks in this environment have a more pronounced effect on real economic variables. We also conduct counterfactual experiments to determine the channels through which uncertainty acts. Uncertainty propagates through both the household consumption channel and through businesses delaying investment, providing substantial contributions to the decline in GDP observed after uncertainty shocks. Finally, we find evidence of the ability of systematic monetary policy to mitigate the adverse effects of uncertainty shocks.
Acknowledgement
The authors benefitted from conversations with Joshua Chan, Mike McCracken, Alessia Paccagnini and from comments by participants at the Applied Time Series Workshop at the St. Louis Fed. The authors thank Kathryn Bokun, Hannah G. Shell, and Julie K. Bennett for research assistance. The views expressed herein reflect those of the authors and should not be taken to reflect those of the Federal Reserve Bank of St. Louis, the Federal Reserve Board of Governors, or the Federal Reserve System.
Appendix
A Computing the GIRFs
Stacking the elements of the VAR, let’s define
where
To construct the impulse response, we first compute the path of the variables for no shock to uncertainty at time t. That is, we compute:
at time t. For the duration of the response, we simulate innovations out to horizon H by drawing random values for
for k = 1, …, K. Obviously, the propagation of the shock will be different if uncertainty is sufficiently high that
To compute
where
In the first case, where when
Should the shock to uncertainty of magnitude δ lead to
In the second scenario, where
For as long as
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