Macroeconomic Transmission of (Un-)Predictable Uncertainty Shocks

Abstract

We document significant upward bias in estimates of the transmission of uncertainty shocks to real activity found in prominent studies of uncertainty's macroeconomic transmission. We show this bias is due to predictability in these uncertainty shocks. The predictability stems not from the use of ex-post revised data rather than real-time data, but from failure to control for uncertainty's endogenous response to changes in economic conditions. We demonstrate two ways of purging uncertainty shocks of their predictable component and find that uncertainty's transmission to output and employment is much smaller than traditional estimates. Instead, we find that uncertainty's relationship with aggregate real activity is more the result of its role as an amplification mechanism for other macroeconomic and financial shocks.