A New Way to Quantify the Effect of Uncertainty

35 Pages Posted: 18 May 2017  

Alexander W. Richter

Federal Reserve Bank of Dallas

Nathaniel A. Throckmorton

College of William and Mary

Date Written: 2017-05-04

Abstract

This paper develops a new method to quantify the effects of uncertainty using estimates from a nonlinear New Keynesian model. The model includes an occasionally binding zero lower bound constraint on the nominal interest rate, which creates time-varying endogenous uncertainty, and two exogenous types of time-varying uncertainty—a volatility shock to technology growth and a volatility shock to the risk premium. A filtered third-order approximation of the Euler equation shows consumption uncertainty on average reduced consumption by about 0.06% and the peak effect was 0.15% during the Great Recession. Other higher-order moments such as inflation uncertainty, technology growth uncertainty, consumption skewness, and inflation skewness had smaller effects. Technology growth volatility explained most of the changes in uncertainty, but risk premium volatility had a major role in the last two recessions.

Keywords: Baysian estimation, uncertainty, stochastic volatility, zero lower bound

JEL Classification: C11, D81, E32, E58

Suggested Citation

Richter, Alexander W. and Throckmorton, Nathaniel A., A New Way to Quantify the Effect of Uncertainty (2017-05-04). FRB of Dallas Working Paper No. 1705. Available at SSRN: https://ssrn.com/abstract=2970281 or http://dx.doi.org/10.24149/wp1705

Alexander W. Richter (Contact Author)

Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States
214-922-5360 (Phone)

HOME PAGE: http://alexrichterecon.com

Nathaniel A. Throckmorton

College of William and Mary ( email )

P.O. Box 8795
Williamsburg, VA 23187
United States

HOME PAGE: http://nathrockmorton.people.wm.edu/

Paper statistics

Downloads
11
Abstract Views
73