Uncertainty, Financial Frictions, and Investment Dynamics

By Simon Gilchrist, J. Sim, Egon Zakraǰsek. 2014

1,020 citations recorded by the source corpus.

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.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/d46cdf2730c84cfd36bf493e931e00b58449f821

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Citations in the corpus

Economic uncertainty and bank risk: Evidence from emerging economies (2020, positive): “Gilchrist et al. (2014) find that uncertainty worsens the financial constraints faced by firms and thus compels down their debt-financed investment.”
Inflation Dynamics and Time-Varying Volatility: New Evidence and an Ss Interpretation* (2014, background): “In addition, a number of recent papers such as Bloom et al. (2012) and Gilchrist et al. (2010) build models where increases in volatility endogenously lead to declines in aggregate productivity.”
Economic policy uncertainty and firm-level investment (2014, positive): “Recent papers by Gilchrist et al. (2010) and Pastor and Veronesi (2012) find that policy uncertainty drives up the cost of finance, lowering investment and intensifying economic contraction.1 1 The view that uncertainty about economic policy may not have major effects has also been advanced.”
Policy uncertainty and corporate credit spreads (2020, neutral): “As argued by Gilchrist et al. (2014), there is robust empirical evidence that credit spreads represent the “most informative and reliable class of financial indicators” of future economic activity.”
What Explains the 2007-2009 Drop in Employment?: The 2007-2009 Drop in Employment (2014, neutral): “…business uncertainty as an explanation for the decline in macroeconomic aggregates (e.g. Baker, Bloom, and Davis (2011), Bloom (2009), Bloom, Foetotto, and Jaimovich (2010), Fernandez-Villaverde, GuerronQuintana, Kuester, and Rubio-Ramirez (2011), and Gilchrist, Sim, and Zakrajsek (2010)).”
Policy Uncertainty and Corporate Investment (2015, neutral): “Uncertainty has been argued to increase the risk of default (e.g. Greenwald and Stiglitz (1990), Gilchrist, Sim, and Zakrajsek (2011)) and the equity risk premium (Pastor and Veronesi (2011)), which would result in higher costs of external financing.”
Aggregate Implications of a Credit Crunch (2012, background): “A growing recent literature argues that financial frictions can cause aggregate productivity losses (Khan and Thomas, 2010; Gilchrist et al., 2010) or manifest themselves in a labor wedge (Jermann and Quadrini, 2009; Arellano, Bai and Kehoe, 2011).(6) We view our paper as complementary to these, but”
Measuring Economic Policy Uncertainty (2016, background): “…reasons for a depressive effect of uncertainty include precautionary spending cutbacks by households, upward pressure on the cost of finance (e.g., Gilchrist et al., 2014, and Pastor and Veronesi, 2013), managerial risk-aversion (e.g., Panousi and Papanikolaou, 2012), and 3 Stock and Watson…”
Aggregate and Idiosyncratic Political Risk: Measurement and Effects (2016, neutral): “…of political risk on asset prices, cost-of-capital, and macroeconomic fluctuations (Pastor and Veronesi (2013, 2012); Belo et al. (2013); Kelly et al. (2016); Koijen et al. (2016); Caldera Sánchez et al. (2016); Gilchrist et al. (2014); Born and Pfeifer (2014); Fernandez-Villaverde et al. (2013)).”
On Measuring Uncertainty and its Impact on Investment: Cross-Country Evidence from the Euro Area (2017, methodology): “5 The heightened interest in uncertainty in the course of the Great Recession prompted the development of numerous uncertainty measures (see, e.g., Bloom, 2014; Gilchrist et al., 2014; Scotti, 2016).”