Working Paper: NBER ID: w24571
Authors: Iván Alfaro; Nicholas Bloom; Xiaoji Lin
Abstract: We show how real and financial frictions amplify, prolong and propagate the negative impact of uncertainty shocks. We first use a novel instrumentation strategy to address endogeneity in estimating the impact of uncertainty by exploiting differential firm exposure to exchange rate, policy, and energy price volatility in a panel of US firms. Using common proxies for financial constraints we show that ex-ante financially constrained firms cut their investment even more than unconstrained firms following an uncertainty shock. We then build a general equilibrium heterogeneous firms model with real and financial frictions, finding financial frictions: i) amplify uncertainty shocks by doubling their impact on output; ii) increase persistence by extending the duration of the drop by 50%; and iii) propagate uncertainty shocks by spreading their impact onto financial variables. These results highlight why in periods of greater financial frictions uncertainty can be particularly damaging.
Keywords: Uncertainty; Financial Frictions; Investment; Economic Crises
JEL Codes: E0; G0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Uncertainty shocks (D89) | Investment rates (G31) |
| Uncertainty shocks (D89) | Employment growth (J23) |
| Uncertainty shocks (D89) | Sales growth (O49) |
| Financial frictions (G19) | Impact of uncertainty shocks on investment rates (D89) |
| Financial frictions (G19) | Impact of uncertainty shocks on output (D89) |
| Uncertainty shocks (D89) | Cash holdings (G19) |
| Uncertainty shocks (D89) | Dividends (G35) |
| Uncertainty shocks (D89) | Debt (H63) |
| Uncertainty shocks (D89) | Financial frictions (G19) |