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Uncertainty Traps

Author

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  • Pablo D. Fajgelbaum
  • Edouard Schaal
  • Mathieu Taschereau-Dumouchel

Abstract

We develop a theory of endogenous uncertainty and business cycles in which short-lived shocks can generate long-lasting recessions. In the model, higher uncertainty about fundamentals discourages investment. Since agents learn from the actions of others, information flows slowly in times of low activity and uncertainty remains high, further discouraging investment. The economy displays uncertainty traps: self-reinforcing episodes of high uncertainty and low activity. Although the economy recovers quickly after small shocks, large temporary shocks may have long-lasting effects on the level of activity. The economy is subject to an information externality but uncertainty traps may remain in the efficient allocation. Embedding the mechanism in a standard business cycle framework, we find that endogenous uncertainty increases the persistence of large recessions and improves the performance of the model in accounting for the Great Recession.

Suggested Citation

  • Pablo D. Fajgelbaum & Edouard Schaal & Mathieu Taschereau-Dumouchel, 2017. "Uncertainty Traps," The Quarterly Journal of Economics, Oxford University Press, vol. 132(4), pages 1641-1692.
  • Handle: RePEc:oup:qjecon:v:132:y:2017:i:4:p:1641-1692.
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    File URL: http://hdl.handle.net/10.1093/qje/qjx021
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Caldara, Dario & Fuentes-Albero, Cristina & Gilchrist, Simon & Zakrajšek, Egon, 2016. "The macroeconomic impact of financial and uncertainty shocks," European Economic Review, Elsevier, vol. 88(C), pages 185-207.
    2. Laurent Ferrara & Stéphane Lhuissier & Fabien Tripier, 2017. "Uncertainty Fluctuations: Measures, Effects and Macroeconomic Policy Challenges," CEPII Policy Brief 2017-20, CEPII research center.
    3. Venky Venkateswaran & Laura Veldkamp & Julian Kozlowski, 2015. "The Tail that Wags the Economy: Belief-Driven Business Cycles and Persistent Stagnation," 2015 Meeting Papers 800, Society for Economic Dynamics.
    4. Alexopoulos, Michelle & Cohen, Jon, 2015. "The power of print: Uncertainty shocks, markets, and the economy," International Review of Economics & Finance, Elsevier, vol. 40(C), pages 8-28.
    5. Julian Kozlowski & Laura Veldkamp & Venky Venkateswaran, 2015. "The Tail that Wags the Economy: Beliefs and Persistent Stagnation," NBER Working Papers 21719, National Bureau of Economic Research, Inc.
    6. repec:spr:jbuscr:v:13:y:2017:i:2:d:10.1007_s41549-017-0020-y is not listed on IDEAS
    7. Ana Figueiredo, 2017. "Uncertainty in education: The role of communities and social learning," 2017 Meeting Papers 529, Society for Economic Dynamics.
    8. Ambrocio, Gene, 2017. "The real effects of overconfidence and fundamental uncertainty shocks," Research Discussion Papers 37, Bank of Finland.
    9. Dow, Sheila, 2016. "Uncertainty: A diagrammatic treatment," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 10, pages 1-25.
    10. N. Bloom., 2016. "Fluctuations in uncertainty," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 4.
    11. Mayumi OjimaAuthor-Name: Junnosuke Shino & Kozo Ueda, "undated". "Buyer-Size Discounts and Inflation Dynamics," Working Papers e71, Tokyo Center for Economic Research.
    12. Sterk, Vincent, 2016. "The dark corners of the labor market," LSE Research Online Documents on Economics 86244, London School of Economics and Political Science, LSE Library.
    13. Pablo D. Fajgelbaum & Edouard Schaal & Mathieu Taschereau-Dumouchel, 2017. "Uncertainty Traps," The Quarterly Journal of Economics, Oxford University Press, vol. 132(4), pages 1641-1692.
    14. Ambrocio, Gene, 2017. "The real effects of overconfidence and fundamental uncertainty shocks," Research Discussion Papers 37/2017, Bank of Finland.
    15. Hikaru Saijo, "undated". "The Uncertainty Multiplier and Business Cycles," Working Papers e67, Tokyo Center for Economic Research.
    16. Hikaru Saijo & Cosmin Ilut, 2015. "Learning, Confidence, and Business Cycles," 2015 Meeting Papers 917, Society for Economic Dynamics.
    17. Shoag, Daniel & Veuger, Stan, 2016. "Uncertainty and the geography of the great recession," Journal of Monetary Economics, Elsevier, vol. 84(C), pages 84-93.
    18. Pablo Kurlat, 2015. "Liquidity as Social Expertise," NBER Working Papers 21118, National Bureau of Economic Research, Inc.
    19. Cascaldi-Garcia, Danilo & Galvao, Ana Beatriz, 2016. "News and Uncertainty Shocks," EMF Research Papers 12, Economic Modelling and Forecasting Group.
    20. Xiaoji Lin & Nicholas Bloom & Ivan Alfaro, 2017. "The Finance-Uncertainty Multiplier," 2017 Meeting Papers 887, Society for Economic Dynamics.
    21. Orlik, Anna & Veldkamp, Laura, 2014. "Understanding Uncertainty Shocks and the Role of Black Swans," CEPR Discussion Papers 10147, C.E.P.R. Discussion Papers.
    22. Sydney C. Ludvigson & Sai Ma & Serena Ng, 2015. "Uncertainty and Business Cycles: Exogenous Impulse or Endogenous Response?," NBER Working Papers 21803, National Bureau of Economic Research, Inc.
    23. Vincent Sterk, 2016. "The Dark Corners of the Labor Market," Discussion Papers 1603, Centre for Macroeconomics (CFM).

    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General

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