The Risk-premium Channel of Uncertainty: Implications for Unemployment and Inflation

Lukas B. Freund, Hanbaek Lee, Pontus Rendahl*

*Corresponding author for this work

Research output: Contribution to journalJournal articleResearchpeer-review

94 Downloads (Pure)

Abstract

This paper studies the role of macroeconomic uncertainty in a search-and-matching framework with risk-averse households. Heightened uncertainty about future productivity reduces current economic activity even in the absence of nominal rigidities. A risk-premium mechanism accounts for this result. As future asset prices become more volatile and covary more positively with aggregate consumption, the risk premium rises in the present. The associated downward pressure on current asset values lowers firm entry, making it harder for workers to find jobs and reducing the supply of goods. With nominal rigidities the recession is exacerbated, as a more uncertain future reinforces households' precautionary behavior, which causes demand to contract. Counterfactual analyses using a calibrated model imply that unemployment would rise by less than half as much absent the risk-premium channel. The presence of this mechanism implies that uncertainty shocks are less deflationary than regular demand shocks, nor can they be fully neutralized by monetary policy.
Original languageEnglish
JournalReview of Economic Dynamics
Volume51
Pages (from-to)117-137
Number of pages21
ISSN1094-2025
DOIs
Publication statusPublished - Dec 2023

Bibliographical note

Published online: 19 December 2022.

Keywords

  • Uncertainty
  • Unemployment
  • Inflation
  • Search frictions

Cite this