The Finance Uncertainty Multiplier
77 Pages Posted: 29 Dec 2017 Last revised: 2 Dec 2021
Date Written: November 30, 2021
We show how real and financial frictions amplify, prolong and propagate the 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. Furthermore, using common proxies for financial constraints, we show that ex-ante financially constrained firms cut their investment more than unconstrained firms following an uncertainty shock. We then build a general equilibrium heterogeneous firms model with real and financial frictions. We show that adding financial frictions: i) amplifies uncertainty shocks by doubling their impact on output; ii) increases persistence by extending the duration of the drop by a half; and iii) propagates 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