Uncertainty, Financial Frictions, and Investment Dynamics

Posted: 9 Jul 2021

See all articles by Simon Gilchrist

Simon Gilchrist

affiliation not provided to SSRN

Jae W. Sim

affiliation not provided to SSRN

Egon Zakrajsek

Bank for International Settlements (BIS)

Date Written: April, 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.

JEL Classification: E22, E32, G31

Suggested Citation

Gilchrist, Simon and Sim, Jae W. and Zakrajsek, Egon, Uncertainty, Financial Frictions, and Investment Dynamics (April, 2014). FEDS Working Paper No. 2014-69, Available at SSRN: https://ssrn.com/abstract=3879388

Simon Gilchrist (Contact Author)

affiliation not provided to SSRN

No Address Available

Jae W. Sim

affiliation not provided to SSRN

No Address Available

Egon Zakrajsek

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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