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Time-Varying Uncertainty And The Credit Channel

  • Victor Dorofeenko
  • Gabriel S. Lee
  • Kevin D. Salyer

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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Article provided by Wiley Blackwell in its journal Bulletin of Economic Research.

Volume (Year): 60 (2008)
Issue (Month): 4 (October)
Pages: 375-403

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Handle: RePEc:bla:buecrs:v:60:y:2008:i:4:p:375-403
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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. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
  5. Greenwood, J. & Hercowitz, Z. & Krusell, P., 1996. "Long-Run Implications of Investment-Specific Technological Change," RCER Working Papers 420, University of Rochester - Center for Economic Research (RCER).
  6. Alderson, Michael J. & Betker, Brian L., 1995. "Liquidation costs and capital structure," Journal of Financial Economics, Elsevier, vol. 39(1), pages 45-69, September.
  7. Maurice Obstfeld & Kenneth Rogoff, 2000. "New Directions for Stochastic Open Economy Models," International Finance 0004002, EconWPA.
  8. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  9. 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.
  10. 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.
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