Really Uncertain Business Cycles

Abstract:We propose uncertainty shocks as a new impulse driving business cycles. First, we demonstrate that uncertainty, measured by a number of proxies is strongly countercyclical. Second, we build a dynamic stochastic general equilibrium model that extends the benchmark neoclassical growth model along two dimensions. It allows for the existence of heterogeneous ?rms with non-convex adjustment costs in both capital and labor and time-variation in uncertainty that is modeled as a change in the variance of innovations to productivity. We ?nd that increases in uncertainty lead to large drops in economic
activity. This occurs because a rise in uncertainty makes ?rms cautious, leading them to pause hiring and investment. It also reduces the reallocation of capital and labor across ?rms, leading to large falls in productivity growth. Finally, we show that because uncertainty makes ?rms cautious it signi?cantly reduces the response of the economy to stimulative policy, leading to pro-cyclical policy multipliers.

Keywords: uncertainty, adjustment costs and business cycles

Authors: Nicholas Bloom, Max Floetotto and Nir Jaimovich

4 Bloom, Floetotto & Jaimovich 2009.pdf