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Uncertainty Traps

  • Pablo Fajgelbaum
  • Edouard Schaal
  • Mathieu Taschereau-Dumouchel

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 unique equilibrium of this economy displays uncertainty traps: self-reinforcing episodes of high uncertainty and low activity. While the economy recovers quickly after small shocks, large temporary shocks may have nearly permanent effects on the level of activity. The economy is subject to an information externality but uncertainty traps may remain even in the efficient allocation. We extend our framework to include additional features of standard business cycle models and show, in that context, that uncertainty traps can substantially worsen recessions and increase their duration.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19973.

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Date of creation: Mar 2014
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Handle: RePEc:nbr:nberwo:19973
Note: EFG
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  1. Pablo N D’Erasmo & Hernan J Moscoso-Boedo, 2011. "Intangibles and Endogenous Firm Volatility over the Business Cycle," Virginia Economics Online Papers 400, University of Virginia, Department of Economics.
  2. Caplin, Andrew & Leahy, John V, 1993. "Sectoral Shocks, Learning, and Aggregate Fluctuations," Review of Economic Studies, Wiley Blackwell, vol. 60(4), pages 777-94, October.
  3. Frankel, David M. & Pauzner, Ady, 2000. "Resolving Indeterminacy in Dynamic Settings: The Role of Shocks," Staff General Research Papers 11924, Iowa State University, Department of Economics.
  4. Ruediger Bachmann & Steffen Elstner & Eric R. Sims, 2010. "Uncertainty and Economic Activity: Evidence from Business Survey Data," NBER Working Papers 16143, National Bureau of Economic Research, Inc.
  5. Gale, D. & Chamley, C., 1992. "Information Revelation and Strategic Delay in a Model of Investment," Papers 10, Boston University - Department of Economics.
  6. Gourio, Francois & Kashyap, Anil K, 2007. "Investment spikes: New facts and a general equilibrium exploration," Journal of Monetary Economics, Elsevier, vol. 54(Supplemen), pages 1-22, September.
  7. Ruediger Bachmann & Christian Bayer, 2009. "Firm-Specific Productivity Risk over the Business Cycle: Facts and Aggregate Implications," 2009 Meeting Papers 869, Society for Economic Dynamics.
  8. Christophe Chamley, 1999. "Coordinating Regime Switches," The Quarterly Journal of Economics, MIT Press, vol. 114(3), pages 869-905, August.
  9. Greg Kaplan & Guido Menzio, 2013. "Shopping Externalities and Self-Fulfilling Unemployment Fluctuations," Working Papers 1461, Princeton University, Department of Economics, Center for Economic Policy Studies..
  10. Zheng Liu & Sylvain Leduc, 2013. "Uncertainty Shocks Are Aggregate Demand Shocks," 2013 Meeting Papers 270, Society for Economic Dynamics.
  11. Ruediger Bachmann & Giuseppe Moscarini, 2011. "Business Cycles and Endogenous Uncertainty," 2011 Meeting Papers 36, Society for Economic Dynamics.
  12. George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2007. "Dynamic Global Games of Regime Change: Learning, Multiplicity, and the Timing of Attacks," Econometrica, Econometric Society, vol. 75(3), pages 711-756, 05.
  13. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 797-817, August.
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