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Endogenous Uncertainty and Credit Crunches

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  • Ludwig Straub

    (Harvard University)

  • Robert Ulbricht

    (Boston College)

Abstract

We develop a theory of endogenous uncertainty in which the ability of investors to learn about firm-level fundamentals is impaired during financial crises. At the same time, higher uncertainty reinforces financial distress. Through this two-way feedback loop, a temporary financial shock can cause a persistent reduction in risky lending, output, and employment that coincides with increased uncertainty, default rates, risk premia and disagreement among forecasters. We embed our mechanism into a standard real business cycle model and show how it manifests as an endogenous and highly internally persistent process for aggregate productivity.

Suggested Citation

  • Ludwig Straub & Robert Ulbricht, 2020. "Endogenous Uncertainty and Credit Crunches," Boston College Working Papers in Economics 1036, Boston College Department of Economics.
  • Handle: RePEc:boc:bocoec:1036
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    Cited by:

    1. Alexander W. Richter & Nathaniel A. Throckmorton, 2017. "A New Way to Quantify the Effect of Uncertainty," Working Papers 1705, Federal Reserve Bank of Dallas.
    2. Robert Ulbricht & Ludwig Straub, 2015. "Endogenous Uncertainty and Credit Crunches," 2015 Meeting Papers 199, Society for Economic Dynamics.
    3. Tyler Atkinson & Michael Plante & Alexander Richter & Nathaniel Throckmorton, 2022. "Complementarity and Macroeconomic Uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 44, pages 225-243, April.
    4. Isaac Baley & Ana Figueiredo & Robert Ulbricht, 2018. "Mismatch Cycles," 2018 Meeting Papers 1098, Society for Economic Dynamics.
    5. Ambrocio, Gene, 2017. "The real effects of overconfidence and fundamental uncertainty shocks," Research Discussion Papers 37/2017, Bank of Finland.
    6. 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.
    7. Gaetano Gaballo, 2016. "Rational Inattention to News: The Perils of Forward Guidance," American Economic Journal: Macroeconomics, American Economic Association, vol. 8(1), pages 42-97, January.
    8. Gete, Pedro & Melkadze, Givi, 2018. "Aggregate volatility and international dynamics. The role of credit supply," Journal of International Economics, Elsevier, vol. 111(C), pages 143-158.
    9. Albagli, Elias & Hellwig, Christian & Tsyvinski, Aleh, 2021. "Dispersed Information and Asset Prices," TSE Working Papers 21-1172, Toulouse School of Economics (TSE).
    10. Straub, Ludwig & Ulbricht, Robert, 2019. "Endogenous second moments: A unified approach to fluctuations in risk, dispersion, and uncertainty," Journal of Economic Theory, Elsevier, vol. 183(C), pages 625-660.
    11. Joshua Bernstein & Michael D. Plante & Alexander W. Richter & Nathaniel A. Throckmorton, 2021. "Countercyclical Fluctuations in Uncertainty are Endogenous," Working Papers 2109, Federal Reserve Bank of Dallas.
    12. Hikaru Saijo & Cosmin Ilut, 2015. "Learning, Confidence, and Business Cycles," 2015 Meeting Papers 917, Society for Economic Dynamics.
    13. Vladimir Asriyan & Luc Laeven & Alberto Martín, 2018. "Collateral Booms and Information Depletion," Working Papers 1064, Barcelona Graduate School of Economics.
    14. Kyriakos T. Chousakos & Gary B. Gorton & Guillermo Ordoñez, 2020. "The Macroprudential Role of Stock Markets," NBER Working Papers 27113, National Bureau of Economic Research, Inc.
    15. Claudio Michelacci & Luigi Paciello, 2020. "Aggregate Risk or Aggregate Uncertainty? Evidence from UK Households," EIEF Working Papers Series 2006, Einaudi Institute for Economics and Finance (EIEF), revised Apr 2020.
    16. Gene Ambrocio, 2020. "Rational exuberance booms," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 35, pages 263-282, January.
    17. Brendon, Charles & Corsetti, Giancarlo, 2016. "COEURE Survey: Fiscal and Monetary Policies after the Crises," CEPR Discussion Papers 11088, C.E.P.R. Discussion Papers.
    18. Joshua Bernstein & Alexander W. Richter & Nathaniel A. Throckmorton, 2021. "Nonlinear Search and Matching Explained," Working Papers 2106, Federal Reserve Bank of Dallas.

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    More about this item

    Keywords

    Endogenous uncertainty; financial crises; internal persistence;
    All these keywords.

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises

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