Divergent effects of aggregate and local uncertainty shocks: Evidence from US metropolitan areas

Abstract

This paper examines how aggregate and local uncertainty shocks affect US metropolitan areas (MSAs). While an extensive literature documents contractionary effects of aggregate uncertainty shocks on the macroeconomy, the MSA-level effects and mechanisms of local uncertainty shocks remain unexplored. Using monthly data on the 50 largest MSAs, we employ a factor-augmented VAR with stochastic volatilities to identify uncertainty shocks through unexpected variations in common and idiosyncratic volatilities. Aggregate uncertainty consistently contracts economic activity across all MSAs, while local uncertainty generates heterogeneous responses, with one-third of MSAs showing expansions. Cross-sectional analysis reveals that aggregate uncertainty operates through strong contractionary channels (financial access, real options, interest-rate policy), while local uncertainty operates through both contractionary and expansionary channels (growth options, expected returns). These findings demonstrate distinct transmission mechanisms between shock types, providing insights for differentiated policy responses.