In‡ation Dynamics and Time-Varying Uncertainty: New Evidence and an Ss Interpretation

Abstract

Is monetary policy less eective during recessions? In this paper, I investigate whether the transmission of monetary policy to the real economy varies across time in micro founded Ss pricing models. I …nd that standard Ss models do not imply time-varying real eects of monetary policy, but these models have counterfactual implications for the dynamics of the distribution of price changes in BLS micro data. I then introduce counter-cyclical uncertainty shocks to match these new micro price facts and show that the price level becomes more ‡exible in times of high uncertainty, which in turn decreases the response of real output to nominal shocks. The estimated response of real output to a nominal shock in October of 2001, a highly uncertain time, is one fourth of the response in September of 1995, a time of low uncertainty. U.S. time-series evidence provides additional support for my model: I show that during times of high uncertainty, exchange rate pass-through to import prices is signi…cantly higher. In addition, the price level responds more strongly to monetary policy in a FAVAR during such periods of uncertainty.

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