Research Discussion Paper – RDP 2017-06 Uncertainty and Monetary Policy in Good and Bad Times

We investigate the role played by systematic monetary policy in the United States in tackling the real effects of uncertainty shocks in recessions and expansions. We model key indicators of the business cycle with a nonlinear vector autoregression model that allows for different dynamics in busts and booms. Uncertainty shocks are identified by focusing on historical events that are associated with jumps in financial volatility. Our results show that uncertainty shocks hitting in recessions trigger a more abrupt drop and a faster recovery in real economic activity than in expansions. Counterfactual simulations suggest that the effectiveness of systematic US monetary policy in stabilising real activity in the aftermath of an uncertainty shock is greater in expansions. Finally, we provide empirical and narrative evidence pointing to a risk management approach by the Federal Reserve.