UNCERTAINTY AND MONETARY POLICY DURING THE GREAT RECESSION

Abstract We employ a nonlinear proxy‐VAR approach to document the large response of real activity to a financial uncertainty shock during and in the aftermath of the Great Recession. We replicate this evidence with an estimated DSGE framework that we employ to quantify the output loss due to the large uncertainty shock that materialized in 2008Q4. We find such a shock to be able to explain about 60% of the output loss in the 2008–2014 period. Our model also points to the powerful role played by the Federal Reserve's systematic monetary policy in limiting the loss of output during the Great Recession.