Uncertainty shocks are aggregate demand shocks

• An increase in uncertainty resembles effects of a negative aggregate demand shock.
• Uncertainty raises unemployment and lowers inflation in both VAR and DSGE models.
• An option-value channel from search frictions amplify effects of uncertainty.
• Presence of nominal rigidities reinforces the option-value channel.

Search frictions in the labor market give rise to a new option-value channel through which uncertainty affects aggregate economic activity, and the effects of which are reinforced by the presence of nominal rigidities. With these features, an increase in uncertainty resembles an aggregate demand shock because it increases unemployment and lowers inflation. Using a new empirical measure of uncertainty based on the Michigan survey and a VAR model, we show that these theoretical patterns are consistent with US data. Using a calibrated DSGE model, we show that combining search frictions and nominal rigidities can match the qualitative VAR pattern and account for about 70 percent of the empirical increase in unemployment following an uncertainty shock.