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Time-Varying Uncertainty and the Credit Channel

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  • Dorofeenko, Victor

    (Department of Economics and Finance, Institute for Advanced Studies, Vienna)

  • Lee, Gabriel S.

    (Department of Economics and Finance, Institute for Advanced Studies, Vienna)

  • Salyer, Kevin D.

    (Department of Economics, University of California)

Abstract

We extend the Carlstrom and Fuerst (1997) agency cost model of business cycles by including time varying uncertainty in the technology shocks that affect capital production. We first demonstrate that standard linearization methods can be used to solve the model yet second moment effects still influence equilibrium characteristics. The effects of the persistence of uncertainty are then analyzed. Our primary findings fall into three broad categories. First, it is demonstrated that uncertainty affects the level of the steady-state of the economy so that welfare analyses of uncertainty that focus entirely on the variability of output (consumption) will understate the true costs of uncertainty. A second key result is that time varying uncertainty results in countercyclical bankruptcy rates – a finding which is consistent with the data and opposite the result in Carlstrom and Fuerst. Third, we show that persistence of uncertainty affects both quantitatively and qualitatively the behavior of the economy.

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File URL: http://www.ihs.ac.at/publications/eco/es-118.pdf
File Function: First version, 2002
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Bibliographic Info

Paper provided by Institute for Advanced Studies in its series Economics Series with number 118.

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Length: 31 pages
Date of creation: Jul 2002
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Handle: RePEc:ihs:ihsesp:118

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Keywords: Agency costs; Credit channel; Time-varying uncertainty;

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References

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  1. Collard, Fabrice & Juillard, Michel, 2001. "A Higher-Order Taylor Expansion Approach to Simulation of Stochastic Forward-Looking Models with an Application to a Nonlinear Phillips Curve Model," Computational Economics, Society for Computational Economics, vol. 17(2-3), pages 125-39, June.
  2. Stephanie Schmitt-Grohe & Martin Uribe, 2005. "Optimal Inflation Stabilization in a Medium-Scale Macroeconomic Model," NBER Working Papers 11854, National Bureau of Economic Research, Inc.
  3. Russell Cooper & Joao Ejarque, 1994. "Financial Intermediation and Aggregate Fluctuations: A Quantative Analysis," NBER Working Papers 4819, National Bureau of Economic Research, Inc.
  4. Maurice Obstfeld & Kenneth Rogoff, 1999. "New Directions for Stochastic Open Economy Models," NBER Working Papers 7313, National Bureau of Economic Research, Inc.
  5. Greenwood, Jeremy & Hercowitz, Zvi & Krusell, Per, 1997. "Long-Run Implications of Investment-Specific Technological Change," American Economic Review, American Economic Association, vol. 87(3), pages 342-62, June.
  6. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," Departmental Working Papers 200106, Rutgers University, Department of Economics.
  7. Alderson, Michael J. & Betker, Brian L., 1995. "Liquidation costs and capital structure," Journal of Financial Economics, Elsevier, vol. 39(1), pages 45-69, September.
  8. Charles T. Carlstrom & Timothy S. Fuerst, 1996. "Agency costs, net worth, and business fluctuations: a computable general equilibrium analysis," Working Paper 9602, Federal Reserve Bank of Cleveland.
  9. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
  10. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
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Cited by:
  1. Rüdiger Bachmann & Peter Zorn, 2013. "What Drives Aggregate Investment?," NBER Working Papers 18990, National Bureau of Economic Research, Inc.
  2. Gregory Clark & Neil Cummins, 2010. "Malthus to Modernity: England’s First Fertility Transition, 1760-1800," Working Papers 1013, University of California, Davis, Department of Economics.
  3. Francisco Covas & Wouter J. Den Haan, 2012. "The Role of Debt and Equity Finance Over the Business Cycle," Economic Journal, Royal Economic Society, vol. 122(565), pages 1262-1286, December.
  4. Kevin D. Salyer & Gabriel S. Lee & Victor Dorofeenko, 2010. "Risk Shocks and Housing Markets," 2010 Meeting Papers 451, Society for Economic Dynamics.
  5. Cesa-Bianchi, Ambrogio & Fernandez-Corugedo, Emilio, 2014. "Uncertainty in a model with credit frictions," Bank of England working papers 496, Bank of England.
  6. Dorofeenko, Viktor & Lee, Gabriel S. & Salyer, Kevin D., 2005. "Agency Costs and Investment Behavior," Economics Series 182, Institute for Advanced Studies.
  7. Bachmann, Rüdiger & Bayer, Christian, 2013. "‘Wait-and-See’ business cycles?," Journal of Monetary Economics, Elsevier, vol. 60(6), pages 704-719.
  8. Viktor Dorofeenko & Gabriel S. Lee & Kevin D. Salyer, 2011. "Rationale Erklärungen für Immobilienpreis‐Bubbles: Die Auswirkungen von Risikoschocks auf die Wohnimmobilienpreisvolatilität und die Volatilität von Investitionen in Wohnimmobilien," Perspektiven der Wirtschaftspolitik, Verein für Socialpolitik, vol. 12(2), pages 151-169, 05.

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