The Finance Uncertainty Multiplier
73 Pages Posted: 29 Dec 2017 Last revised: 23 Dec 2022
Date Written: December 20, 2022
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, Employment, Cash holding, Equity payouts
JEL Classification: D22, E23, E44, G32
Suggested Citation: Suggested Citation