The Inflation Uncertainty Amplifier

We study how uncertainty shocks affect the macroeconomy across the inflation cycle using a nonlinear stochastic volatility-in-mean VAR. When inflation is high, uncertainty shocks raise inflation and depress real activity more sharply. A non-linear New Keynesian model with second-moment shocks and trend inflation explains this via an 'inflation-uncertainty amplifier': the interaction between high trend inflation and firms' upward price bias magnifies the effects of uncertainty by increasing price dispersion. An aggressive policy response can replicate the allocation achieved under standard policy when trend inflation is low.