Uncertainty Matters: Evidence from a High-frequency Identification Strategy

Abstract

Assessing the role of uncertainty shocks as a driver of business cycle fluctuations is challenging because spikes in uncertainty often coincide with news about economic fundamentals. To tackle this problem, we exploit daily data to identify uncertainty shocks that (i) impact the VXO volatility index, and (ii) are statistically independent from level shocks affecting stock prices. We then use the identified series of uncertainty shocks in a monthly VAR to estimate their macroeconomic effects on the US economy. An exogenous increase in uncertainty depresses economic activity and prices, significantly affecting both labor and capital goods markets. Uncertainty shocks account for about 20% of the cyclical fluctuations in employment and industrial production.