Uncertainty and Policy Ineffectiveness: A Macroeconomic Model with Markov Chains

Abstract

The main objective of this thesis is the study of a new economic relationship between uncertainty (of agents in an economy) and the effectiveness of policy (either fiscal or monetary). To do so, this work develops a theoretical macroeconomic model based on Markov chains, which illustrates that raising uncertainty perceived by economic agents can lower the effectiveness of monetary and fiscal policies, defined as its ability to modify the Gross Domestic Product (GDP). Next, an econometric approach is taken in order to assess whether these conclusions translate to an empirical framework, and results support the model’s conclusions with Spanish data from 1995-2018.