Working Paper: NBER ID: w20038
Authors: Simon Gilchrist; Jae W. Sim; Egon Zakrajsek
Abstract: Micro- and macro-level evidence indicates that fluctuations in idiosyncratic uncertainty have a large effect on investment; the impact of uncertainty on investment occurs primarily through changes in credit spreads; and innovations in credit spreads have a strong effect on investment, irrespective of the level of uncertainty. These findings raise a question regarding the economic significance of the traditional "wait-and-see" effect of uncertainty shocks and point to financial distortions as the main mechanism through which fluctuations in uncertainty affect macroeconomic outcomes. The relative importance of these two mechanisms is analyzed within a quantitative general equilibrium model, featuring heterogeneous firms that face time-varying idiosyncratic uncertainty, irreversibility, nonconvex capital adjustment costs, and financial frictions. The model successfully replicates the stylized facts concerning the macroeconomic implications of uncertainty and financial shocks. By influencing the effective supply of credit, both types of shocks exert a powerful effect on investment and generate countercyclical credit spreads and procyclical leverage, dynamics consistent with the data and counter to those implied by the technology-driven real business cycle models.
Keywords: Uncertainty; Investment; Financial Frictions; Credit Spreads
JEL Codes: E22; E32; G31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fluctuations in idiosyncratic uncertainty (D89) | Changes in credit spreads (G19) |
| Changes in credit spreads (G19) | Investment dynamics (G11) |
| Fluctuations in idiosyncratic uncertainty (D89) | Investment dynamics (G11) |
| Fluctuations in idiosyncratic uncertainty (D89) | Real GDP (E20) |
| Financial market frictions (G19) | Response of investment to uncertainty shocks (D89) |