DP12139 News, Uncertainty and Economic Fluctuations

Author(s): Mario Forni, Luca Gambetti, Luca Sala
Publication Date: July 2017
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12139

We formalize the idea that uncertainty is generated by news about future developments in economic conditions which are not perfectly predictable by the agents. Using a simple model of limited information, we show that uncertainty shocks can be obtained as the square of news shocks. We develop a two-step econometric procedure to estimate the effects of news and we find highly nonlinear effects. Large news shocks increase uncertainty. This mitigates the effects of good news and amplifies the effects of bad news in the short run. By contrast, small news shocks reduce uncertainty and increase output in the short run. The Volcker recession and the Great Recession were exacerbated by the uncertainty effects of news.