Working Paper: CEPR ID: DP14690
Authors: Pontus Rendahl; Lukas Freund
Abstract: This paper studies the role of uncertainty in a search-and-matching framework with risk-averse households. A mean-preserving spread to future productivity contracts current economic activity even in the absence of nominal rigidities, although the effect is reinforced by the presence of the latter. That is, uncertainty shocks carry both contractionary demand- and supply effects. The reason is that a more uncertain future increases the precautionary behavior of households, which reduces interest rates and contracts demand. At the same time, as future asset prices becomes more volatile and positively covary with aggregate consumption, households demand a larger risk premium, which puts negative pressure on current asset values and thereby contracts supply. Thus, in comparison to a pure negative demand shock, an uncertainty shock puts less deflationary pressure on the economy and, as a result, renders a flatter Phillips curve.
Keywords: Uncertainty; Unemployment; Inflation; Search Frictions
JEL Codes: J64; E21; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in uncertainty (D89) | increase in precautionary saving (E21) |
| increase in precautionary saving (E21) | reduction in demand (D12) |
| reduction in demand (D12) | increase in unemployment (J64) |
| uncertainty shock (D89) | contraction in demand and supply (J20) |
| contraction in demand and supply (J20) | flatter Phillips curve (E31) |
| increase in uncertainty (D89) | reduction in demand (D12) |
| increase in uncertainty (D89) | increase in unemployment (J64) |