Uncertainty Shocks in a Model of Effective Demand: Comment

15 Pages Posted: 1 Jun 2017 Last revised: 13 Jun 2018

See all articles by Alexander W. Richter

Alexander W. Richter

Federal Reserve Bank of Dallas

Oliver de Groot

Board of Governors of the Federal Reserve System

Nathaniel A. Throckmorton

William & Mary

Date Written: May, 2017

Abstract

Basu and Bundick (2017) show a second moment intertemporal preference shock creates meaningful declines in output in a sticky price model with Epstein and Zin (1991) preferences. The result, however, rests on the way they model the shock. If a preference shock is included in Epstein-Zin preferences, the distributional weights on current and future utility must sum to 1, otherwise it creates an asymptote in the response to the shock with unit intertemporal elasticity of substitution. When we change the preferences so the weights sum to 1, the asymptote disappears as well as their main results—uncertainty shocks generate small increases in output and comovement with consumption and investment that is at odds with the data. We examine three changes to the model—recalibration, a risk-premium shock, and a disaster risk-type shock—to try and restore their results, but in all three cases the model is unable to match VAR evidence.

JEL Classification: D81, E32

Suggested Citation

Richter, Alexander W. and de Groot, Oliver and Throckmorton, Nathaniel A., Uncertainty Shocks in a Model of Effective Demand: Comment (May, 2017). FRB of Dallas Working Paper No. 1706, Available at SSRN: https://ssrn.com/abstract=2978556 or http://dx.doi.org/10.24149/wp1706

Alexander W. Richter

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

Oliver De Groot (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Nathaniel A. Throckmorton

William & Mary ( email )

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

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

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