Uncertainty over ‘uncertainty’

Today John Taylor provided a summary of topics discussed in a conference on uncertainty held last week at the Dallas Fed:

It was a terrific conference with a great deal of value added by the academic papers.  Larry Christiano, for example, demonstrated that there was a surprisingly strong correlation between the business cycle and cross-sectional industry variability (a measure of “risk shocks” not necessarily related to policy), and showed how this correlation can be explained with a particular dynamic stochastic model with a financial sector. Steve Davis pointed out that his data on policy uncertainty (produced along with Nick Bloom and Scott Baker) provided evidence of a recent policy climate change—not simply spikes around the time of debt limit debates. Laura Veldkamp and Anna Orlik showed that model uncertainty is a big source of uncertainty shocks and that the non-normal distribution of shocks explains unusual patterns of economic forecasts.

Sylvain Leduc and Zheng Liu have also just released a working paper entitled: “UNCERTAINTY SHOCKS ARE AGGREGATE DEMAND SHOCKS”. From their conclusion:

To help understand the transmission mechanisms of uncertainty shocks, we present a DSGE model with search frictions and nominal rigidities. We show that interactions between search frictions and nominal rigidities help significantly amplify the macroeconomic effects of uncertainty shocks. Absent either friction, the recessionary effects of an uncertainty shock would be substantially muted. Consistent with the evidence, our DSGE model predicts that an uncertainty shock, regardless of its source, raises unemployment and lowers inflation and the nominal interest rate, and thus acts like a negative aggregate demand shock.

When a monetary anomaly happens, like it did in 2008, people branch off in all directions and don´t focus on the anomaly itself as the cause, preferring to go out and look for “needles in haystacks”!