Uncertainty, Financial Frictions, and Investment Dynamics

60 Pages Posted: 1 Oct 2014

See all articles by Simon Gilchrist

Simon Gilchrist

National Bureau of Economic Research (NBER)

Jae Sim

Board of Governors of the Federal Reserve System

Egon Zakrajšek

Federal Reserve Bank of Boston

Multiple version iconThere are 2 versions of this paper

Date Written: April 1, 2014

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: Time-varying volatility, asset specificity, capital liquidity shocks, costly external finance, firm heterogeneity, general equilibrium

JEL Classification: E22, E32, G31

Suggested Citation

Gilchrist, Simon and Sim, Jae W. and Zakrajšek, Egon, Uncertainty, Financial Frictions, and Investment Dynamics (April 1, 2014). FEDS Working Paper No. 2014-69, Available at SSRN: https://ssrn.com/abstract=2503636 or http://dx.doi.org/10.2139/ssrn.2503636

Simon Gilchrist

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jae W. Sim

Board of Governors of the Federal Reserve System ( email )

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Washington, DC 20551
United States

Egon Zakrajšek (Contact Author)

Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

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