Complementarity and Macroeconomic Uncertainty

Abstract

Abstract Macroeconomic uncertainty regularly fluctuates in the data. Theory suggests complementarity between capital and labor inputs in production can generate time-varying endogenous uncertainty because the concavity in the production function influences how output responds to productivity shocks in different states of the economy. This paper examines whether complementarity is a quantitatively significant source of time-varying endogenous uncertainty by estimating a nonlinear real business cycle model with a constant elasticity of substitution production function and exogenous volatility shocks. When matching labor share and uncertainty moments, we find at most 16% of the volatility of uncertainty is endogenous. An estimated model without exogenous volatility shocks can endogenously generate all of the empirical variation in uncertainty, but only at the expense of significantly overstating the volatility of the labor share.