This paper proposes a novel method for solving dynamic stochastic general equilibrium models that feature heterogeneity in household income and wealth, aggregate uncertainty about the future state of the economy, and the presence of nonlinearities such as the ZLB on nominal interest rates.
The model shows that negative demand shocks have a relatively larger impact on the economy when there are uncertainty and aggregate nonlinearities. For instance, the zero lower bound (ZLB) on nominal interest rates increases the uncertainty about monetary policy efficacy, amplifying the effects of a negative demand shock. Heterogeneity in household income and wealth further emphasizes the role of uncertainty, as it leads to precautionary savings behavior.
