A Note on Uncertainty and Growth with Recursive Preferences

Abstract

There is cross-country and time-series evidence that volatility is associated with slower growth. However, matching this evidence has proven to be a challenge for growth models without market failures, as they tend to predict the opposite for values of risk aversion greater than unity. This note studies the relationship between uncertainty and long-term growth in a complete markets economy with Epstein-Zin preferences and where the accumulation of human and physical capital drives unbounded growth. With these preferences, risk aversion and intertemporal elasticity of substitution are allowed to be independent of one another. When both are relatively high, the relationship between volatility and growth turns out to be negative.

Keywords: Growth and Uncertainty, Epstein-Zin Preferences, Intertemporal Elasticity of Substitution, Risk Aversion

JEL Classification: D92, E22, E32, O49