Uncertainty has recently become a major concern for policymakers and academics. Spikes in uncertainty are often associated with recessions and have detrimental effects on the aggregate economy.
This paper analyzes the effects of uncertainty on firms' hiring and investment decisions, both empirically and theoretically. Empirically, VAR estimates show the negative effects of uncertainty on economic performance and in particular on the labor market. Counterfactual experiments highlight the significant role of hiring decisions as a transmission channel for uncertainty.
The empirical findings are rationalized through a DSGE model with search and matching frictions in the labor market and stochastic volatility. The model is able to replicate the observed co-movement among consumption, investment, output and labor market outcomes generated by an uncertainty shock. Price stickiness greatly amplifies the reaction of the economy. Simulations show that monetary policy can mitigate the adverse effects of uncertainty by adopting a strong anti-inflationary policy.