Decision Making Under Uncertainty – DEMUR

The studies used a variety of empirical and theoretical methods. Throughout the project, several risk measures were developed, including risks associated with exchange rates, cross-country volatility, and regional import tariff volatility. In addition, macroeconomic models, most often estimated, were used to determine the channels of transmission of uncertainty, particularly through financial markets, currency markets, and international trade.

The DEMUR project proposes different measures of economic uncertainty. It shows that macroeconomic uncertainty has detrimental effects on the economy, particularly because it negatively impacts agents' expectations. In the financial market or the government bond market, this impact can be significant when there are financial frictions. The project shows that capital flows are also sensitive to uncertainty, particularly when it concerns commodity prices. Finally, the project highlights the heterogeneous effects on the economy, at the macroeconomic, geographical, and sectoral levels.

Macroeconomic uncertainty affects agents' behavior, both through their decisions on savings, investment, and the labor market. With countries interconnected through international trade and geopolitical issues, the international dimension seems increasingly omnipresent in the analysis of the effects of uncertainty.

Over the last years, uncertainty has become a major challenge that private and public decision makers had to deal with. The most recent event of global (or aggregate) uncertainty is the spread of the COVID-19, which results in a peak of uncertainty similar to the Great Depression of 1929 (see Baker et al., 2020). This exceptional event that we are currently experiencing features uncertainty on several dimensions, like the duration of the spread of the virus, the transmission of the crisis to financial markets, the evolution of unemployment and inequalities during the lockdown or the ability of the economies to recover or to adapt to a new regime. The COVID-crisis disturbs linkages between economic players since it generates a collapse in both supply and demand and it is very likely that it be to one of the strongest recessions that the worldwide economy has experienced over the last decades.
Uncertainty happens when people are unable to predict the likelihood of events they will face in the future. It is usually acknowledged that global uncertain events have large adverse effects on the economic activity through its impacts on individual decisions. For instance, firms tend to postpone investment and hiring decisions (see Bloom, 2014, for a survey). One striking example is the outcome of the Brexit referendum in 2016: It has kept firms doubtful for more than three years regarding the future economic environment and in turn has led to a significant UK output reduction and more dispersed expectations about future prospects (see Born et al., 2019; Tripier, 2019). Uncertainty also generates income insecurity for households, who are more willing to adopt precautionary saving and labour behaviours. Consequently, the analysis of aggregate uncertainty cannot be dissociated from studying heterogeneous responses of agents.

This research proposal seeks to analyse decision making under aggregate uncertainty, with a special focus on labour market outcomes. Albeit, “decision making” refers to individual behaviours, aggregate uncertainty events have by definition macroeconomics consequences as they disturb a large set of decision makers. Following Ghironi’s guidance “Macro needs Micro” (see Ghironi, 2018), we will therefore resort to large set of empirical micro (or disaggregated) databases to highlight the macroeconomic consequences of aggregate uncertainty through the lens of the heterogeneous behaviour of agents.

To reach this objective, this research proposal focuses on three transmission channels of uncertainty. The first task focuses on labour market adjustments (Task 1), since firms and households usually have incentives to adjust labour market decisions in order to self-ensure against uncertainty. Motivated by the growing trend of worldwide interconnectedness over the last decades, the second task looks at the international market dimension of uncertainty (Task 2). Finally, the third task is interested in some unexplored links between uncertainty and financial markets (Task 3), the latter being strong amplification channels of uncertainty. Through these three markets, this research proposal aims at providing a comprehensive overview of the direct and indirect transmission channels of global uncertainty to the labour market and the primary economic linkages between individual agents.