Uncertainty Shocks and the Great Recession: Nonlinearities Matter

We show that a nonlinear DSGE framework estimated on moments (impulse responses) specific to the great recession implies a peak response of the cyclical component of output to an uncertainty shock 50% larger than the one predicted by the very same model estimated on moments implied by a standard linear VAR. As an implication, the DSGE framework estimated on impulse responses generated with the nonlinear VAR assigns to the 2008Q4 uncertainty shock a contribution of about 60% as regards the output loss experienced by the US economy during and after the great recession. The same DSGE framework estimated by matching the impulse responses of the linear VAR severely underestimates such contribution.