Abstract

We investigate the effects of monetary uncertainty on the aggregate economy, especially default. First, we estimate monetary policy for the U.S. that allows for time-varying volatility to bring in monetary uncertainty. Then, we assign productivity, money policy and monetary uncertainty shock to a dynamic general equilibrium model with default that is calibrated with the U.S. economy. It reveals that monetary uncertainty has a negative effect on the economic activity and results in default issue. An increase of risk aversion among agents is the primary cause of investment delays and dries up liquidity temporarily while a decrease in the output serves as an intermediate step in the transmission mechanism of monetary uncertainty.