Measuring macroeconomic uncertainty

This thesis aims to measure aspects of monetary policy uncertainty and evaluate their impact on the economy. The first chapter extends a short-term interest rate uncertainty measure of Bundick et al. (2017) by using option implied volatility of Eurodollar rates. Impulse responses show that increases in short-term interest rate uncertainty have an adverse impact on the real economy due to the presence of financial frictions; deterioration in risk appetite in the corporate bond market—measured by the excess bond premium—raises the costs of financing, thereby reducing investment and hiring. The second chapter investigates how market-perceived uncertainty about the U.S. Federal Reserve’s monetary policy affects the transmission of monetary policy shocks on government bond yields. We first construct a parsimonious model with a simple interest rate rule to demonstrate that perceived monetary policy uncertainty in the financial market is driven by uncertainties surrounding future macroeconomic conditions and the uncertainty of monetary policy shocks. We then provide empirical evidence to support the model’s prediction that the market perceived policy uncertainty is related to measures of uncertainty communicated through policy announcements, and how these policy commitments are communicated. Our results suggest that such monetary policy uncertainty moderates the impact of forward guidance shocks on long-term government bond yields, and that the moderating process is delivered through changes in the term premium rather than the expected component of yields. The third chapter introduces a new measure of perceived monetary policy uncertainty among U.S. non-financial publicly listed firms and examines this uncertainty’s influence on firms’ investment decisions. Using a dictionary-based textual analysis, we quantify perceived monetary policy uncertainty as the proportion of terms related to monetary policy used in conjunction with uncertainty in firms’ earnings conference call transcripts. Our findings indicate that perceived monetary policy uncertainty not only directly reduces firms’ investment but also moderates the effects of federal funds rate shocks and forward guidance shocks, and amplifies the role of large asset purchase shocks in driving firm investment.