When it Rains it Pours: Cascading Uncertainty Shocks

65 Pages Posted: 25 Aug 2020

See all articles by Anthony M. Diercks

Anthony M. Diercks

Board of Governors of the Federal Reserve System: Monetary and Financial Market Analysis

Alex Hsu

Georgia Institute of Technology - Scheller College of Business

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick

Multiple version iconThere are 2 versions of this paper

Date Written: August 1, 2020

Abstract

We empirically document that serial uncertainty shocks are (1) common in the data and (2) have an increasingly stronger impact on the macroeconomy. In other words, a series of bad (positive) uncertainty shocks exacerbates the economic decline significantly. From a theoretical perspective, these findings are puzzling: existing benchmark models do not deliver the observed amplification. We show analytically that a state dependent precautionary motive with respect to uncertainty shocks is required. Our derivations suggest that the state dependent precautionary motive only shows up at fourth order approximations or higher. Fundamentally, in DSGE models solved with perturbations, agents have always possessed a state dependent precautionary motive but typical solution methods were hiding this fact. Future studies need to consider solving the model via fourth (or higher) order perturbation in order to avoid understating the effect of uncertainty shocks that occur in succession.

Keywords: Dynamic Equilibrium Economies, Stochastic Volatility, Perturbation

JEL Classification: C63, C68, E37

Suggested Citation

Diercks, Anthony M. and Hsu, Alex and Tamoni, Andrea, When it Rains it Pours: Cascading Uncertainty Shocks (August 1, 2020). FEDS Working Paper No. 2020-064, Available at SSRN: https://ssrn.com/abstract=3680252 or http://dx.doi.org/10.17016/FEDS.2020.064

Anthony M. Diercks (Contact Author)

Board of Governors of the Federal Reserve System: Monetary and Financial Market Analysis ( email )

20th and C Streets, NW
Washington, DC 20551
United States

Alex Hsu

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States
4043851123 (Phone)

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

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