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Growth, Uncertainty and Finance

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  • K Blackburn
  • D Varvarigos
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    Abstract

    We study the effects of uncertainty on long-run growth in two model economies, where households fund risky investment projects of entrepreneurs in the presence of financial market imperfections. Imperfections in the first model are due to asymmetric information which is resolved through costly state verification. In this case, some entrepreneurs may decide at the outset not to borrow and not to run projects. Imperfections in the second model are due to incomplete enforceability of loan contracts. In this case, all entrepreneurs are willing to borrow, but some of them may choose not to run projects, preferring to abscond with their loans, instead. We show that, in both cases, an increase in uncertainty increases the rate of interest on loans which increases the number of entrepreneurs who abstain from running projects. This reduces capital accumulation and growth. We also show that financial market frictions have similar effects, and that the effects of uncertainty disappear when these frictions are absent.

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    File URL: http://www.socialsciences.manchester.ac.uk/medialibrary/cgbcr/discussionpapers/dpcgbcr48.pdf
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    Bibliographic Info

    Paper provided by Economics, The Univeristy of Manchester in its series Centre for Growth and Business Cycle Research Discussion Paper Series with number 48.

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    Length: 25 pages
    Date of creation: 2005
    Date of revision:
    Handle: RePEc:man:cgbcrp:48

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