Uncertainty and Monetary Policy During the Great Recession

Abstract

We employ a nonlinear VAR framework and a state-of-the-art identi…cation strategy to document the large response of real activity to a …nancial uncertainty shock during and in the aftermath of the great recession. We replicate this evidence with an estimated DSGE framework featuring a concept of uncertainty comparable to that in our VAR. We then use the estimated framework to quantify the output loss due to the large uncertainty shock that materialized in 2008Q3. We …nd such a shock to be able to explain about 60% of the output loss in the 2008-2014 period. The same estimated model unveils the role successfully played by the Federal Reserve in limiting the output loss that would otherwise have occurred had monetary policy been conducted as in normal times. Finally, we show that the rule estimated during the great recession is able to deliver an economic outcome closer to the ‡exible price one than the rule describing the Federal Reserve's conduct in normal times.

Global financial uncertainty

“…Our empirical findings on the recessionary effects of financial uncertainty shocks at a global level support the predictions of models featuring either external uncertainty shocks hitting open economies (Benigno et al, 2012; Born & Pfeifer, 2014; Chatterjee, 2019; Fernández‐Villaverde et al, 2011; Handley & Limão, 2017; Mumtaz & Theodoridis, 2015) or global volatility shocks (Gourio et al, 2013). Our results—based on a world‐level dataset—that GFU shocks are relevant drivers of world output echoes those on the role of financial uncertainty for the US business cycle (see, e.g., Basu & Bundick, 2017; Caggiano et al, 2014, 2022; Leduc & Liu, 2016; Ludvigson et al, 2021), above all in periods of high economic and financial stress such as the great recession (Alessandri & Mumtaz, 2019; Caggiano et al, 2017, 2021; Pellegrino et al, 2022).…”