A New Way to Quantify the Effect of Uncertainty

This paper develops a new way to quantify the effect of uncertainty that not only accounts for exogenous sources of uncertainty but also uncertainty that naturally arises in general equilibrium models, which we refer to as... [ view full abstract ]

This paper develops a new way to quantify the effect of uncertainty that not only accounts for exogenous sources of uncertainty but also uncertainty that naturally arises in general equilibrium models, which we refer to as endogenous uncertainty. Our approach has two key steps. First, we estimate a nonlinear model with data on macro and financial uncertainty, which inform the sources of uncertainty in our model. Second, we use the Euler equation to decompose consumption and then filter the data at the posterior mean to create a time series for each term in the decomposition. The methodology is applicable to most macro models. Our model includes a zero lower bound constraint on the nominal interest rate, which creates time-varying endogenous uncertainty, and two exogenous volatility shocks. We find consumption uncertainty on average reduced current consumption by about 0.06% and the peak effect was 0.15% during the Great Recession. Other types of uncertainty and skewness had much smaller effects.