This paper investigates the effects of uncertainty on the macro economy by replicating the micro effects of uncertainty on individual subjective beliefs. In our model, the representative household has smooth ambiguity preferences and is uncertain about which scenario the economy will be in the next period: normal growth or recession. We anchor the ratio of expected utilities between the two scenarios through the empirical macroeconomic uncertainty index. The higher the macroeconomic uncertainty rises, the deeper the recession that the household is expecting. Our estimations demonstrate that the smooth ambiguity model with an appropriate level of ambiguity aversion outperforms the benchmark model with no uncertainty in fitting output growth rate, especially during recessions. This holds true even when tested with out-of-sample forecasts. Finally, our analysis reveals that the Global Financial Crisis was associated with an increase in both risk aversion and ambiguity aversion, while the Dot-com Crisis only affected risk aversion.

Macroeconomic uncertainty affects the subjective distribution of individual expectations. Using four panel datasets, we document the effects of macro uncertainty on the mean expectation (first moment) and subjective uncertainty (second moment) of income forecasts. We find that macro uncertainty reduces the mean expectation of income when using professional forecasters’ data as most macroeconomic models assume. However, macro uncertainty does not have a monotonic effect on subjective uncertainty. This finding is at odds with most models, which assume higher individual subjective uncertainty as the microfoundation for the impact of uncertainty on decision-making.