Department of Economics and Business Economics

Martin Møller Andreasen

Why Does Risk Matter More in Recessions than in Expansions?

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This paper uses a nonlinear vector autoregression and a non-recursive identification strategy to show that an equal-sized uncertainty shock generates a larger contraction in real activity when growth is low (as in recessions) than when growth is high (as in expansions). An estimated New Keynesian model with recursive preferences and approximated to third order around its risky steady state replicates these state-dependent responses. The key mechanism behind this result is that firms display a stronger upward nominal pricing bias in recessions than in expansions, because recessions imply higher inflation volatility and higher marginal utility of consumption than expansions.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages41
Publication statusPublished - 29 Sep 2021
SeriesEconomics Working Papers
Number2021-12

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