Uncertainty and the Great Recession
| DOI | http://doi.org/10.1111/obes.12229 |
| Published date | 01 October 2018 |
| Date | 01 October 2018 |
951
©2017 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd.
OXFORD BULLETIN OF ECONOMICSAND STATISTICS, 80, 5 (2018) 0305–9049
doi: 10.1111/obes.12229
Uncertainty and the Great Recession*
Benjamin Born,†Sebastian Breuer‡ and Steffen Elstner§
†University of Bonn, CEPR, and CESifo, 53113, Bonn, Germany (e-mail: born@uni-bonn.
de)
‡German Council of Economic Experts, Wiesbaden, Germany (e-mail: sebastian.breuer@
svr-wirtschaft.de)
§RWI Essen, Essen, Germany (e-mail: steffen.elstner@rwi-essen.de)
Abstract
Has heightened uncertainty been a major contributor to the Great Recession and the slow
recovery in the United States? To answer this question, we identify exogenous changes in
six uncertainty proxies and quantify their contributions to GDP growth and the unemploy-
ment rate. The answer is no. In total we find that increased macroeconomic and financial
uncertainty can explain up to 10% of the drop in GDP at the height of the recession and
up to 0.6 percentage points of the increased unemployment rates in 2009 through 2011.
Our calculations further suggest that only a minor part of the rise in popular uncertainty
measures during the Great Recession was driven by exogenous uncertainty shocks.
I. Introduction
How much has increased uncertainty contributed to the Great Recession and the ensuing
weak recovery in the United States? This question has captivated economists, politicians,
and the blogosphere alike, the popular argument being that uncertainty reduces firms’
hiring and investment and consumers’ spending. However, while the literature on the
effects of fluctuations in uncertainty on economic activity has rapidly expanded fol-
lowing the seminal paper by Bloom (2009),1few papers have actually quantified the
specific effects of uncertainty on US GDP and unemployment in the aftermath of the finan-
cial crisis. In a ‘back-of-the-envelope’ calculation, Bloom (2014) reckons that the rise in
uncertainty in 2008 potentially accounted for a 3 percentage point loss in GDP in 2008
and 2009. Baker, Bloom and Davis (2016) find that the increase in policy uncertainty
during the years 2006 to 2011 can be connected to a decline in industrial production of
JEL Classification numbers: C32, E32.
*Wewould like to thank the editor, twoanonymous referees, R ¨udiger Bachmann, Johannes Pfeifer, and participants
at the 2015 World Congress of the Econometric Society, the 2015 EEA meeting, the 2015Annual Meeting of the
Royal Economic Society, the 2014 Annual Meeting of the Verein f¨ur Socialpolitik, and seminar audiences at IFO
Institute Munich and Deutsche Bundesbank for helpful comments and suggestions.
1See Bloom (2014) for a survey.
952 Bulletin
1.1%.2For the US unemployment rate, Leduc and Liu (2016) find that uncertainty shocks
account for a 1 percentage point increase during the crisis and recovery.3
We contribute to this literature by providing quantitative estimates of the pure uncer-
tainty effects on the US economy since 2008, against which the predictions of macro-
economic models can be compared. To this end, we use a unified framework to identify
monthly exogenous shocks across a wide range of uncertainty proxies and compute his-
torical decompositions to determine the effects of these identified uncertainty shocks on
GDP growth and the unemployment rate during the Great Recession and the subsequent
slow recovery. Using historical decompositions instead of the usual forecast-error variance
decompositions also allows us to quantify how much of the fluctuations in commonlyused
uncertainty measures can actually be attributed to exogenous uncertainty shocks during
the Great Recession and its aftermath.
Employing a wide range of uncertainty proxies has the advantage of capturing differ-
ent kinds of uncertainty, such as among others (aggregate) macroeconomic uncertainty
(Jurado, Ludvigson and Ng, 2015), financial uncertainty (Ludvigson, Ma and Ng, 2017),
(idiosyncratic) firm-specific uncertainty (Bachmann et al., 2013a; Bachmann, Elstner and
Sims, b), and economic policy uncertainty (Baker et al., 2016). At the same time these
measures are constructed using very different approaches, e.g. the common volatility in the
unforecastable component of a large number of economic indicators (Jurado et al., 2015)
or newspaper searches (Baker et al., 2016), further robustifying our results. The monthly
uncertainty proxies allow us to identify uncertainty shocks in a monthly SVAR where iden-
tifying timing assumptions are less strong compared to the quarterly case. However, the
caveat of the monthlyfrequency in earlier studies is that they relied on industrial production
as a measure of real activity, a measure that only accounts for about 12% of US GDP. By
using interpolated GDP, we can identify the shocks at the monthly level, clean them of
confounding factors, and still look at the response of total GDP to an uncertainty shock.
Our results are the following. First, onlya minor par t of the largeincrease in uncer tainty
measures during the Great Recession is due to exogenous uncertainty shocks. They seem
to contain a large endogenous component mostly driven by first-moment shocks. That is,
the role of uncertainty might be overstated when not controlling appropriately for con-
comitant level effects. Second, estimating the growth contributions of uncertainty to GDP
growth and unemployment, we find that uncertainty explained, at a maximum (across all
measures), about 10% of the drop in GDP at the height of the Great Recession, i.e. over
the 2008/09 period. However, financial uncertainty shocks are able to explain an increase
in the unemployment rate by up to 0.6 percentage points in 2011, supporting the view that
uncertainty shocks might be a contributor to the ‘jobless recovery’ after the crisis. Our
results are broadly robust across different uncertainty proxies and modelling assumptions.
Interestingly, despite being widely discussed in political and economic circles, economic
policy uncertainty plays only a minor role.
2However, Benati (2014) finds little evidence for the notion that economic policy uncertainty had an important
role during the Great Recession. This is in line with Born and Pfeifer (2014) who find that policy uncertainty has had
in general only small effects on post-World War II US business cycles.
3There is also an important strand of the literature that investigates the effect of changes in the volatility of
monetary policy shocks on macroeconomic outcomes, see Mumtaz and Zanetti (2013), Mumtaz and Surico (2015),
and Mumtaz and Theodoridis (2017).
©2017 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd
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