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. While 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.
|Date of creation:||Mar 2014|
|Date of revision:|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
Web page: http://www.nber.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- 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.
- R?diger Bachmann & Steffen Elstner & Eric R. Sims, 2013. "Uncertainty and Economic Activity: Evidence from Business Survey Data," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(2), pages 217-49, April.
- Steffen Elstner & Eric Sims & Ruediger Bachmann, 2010. "Uncertainty and Economic Activity: Evidence from Business Survey Data," 2010 Meeting Papers 614, Society for Economic Dynamics.
- Eric R. Sims, 2012. "Uncertainty and Economic Activity: Evidence from Business Survey Data," Working Papers 014, University of Notre Dame, Department of Economics, revised Jun 2012.
- Christophe Chamley, 1999. "Coordinating Regime Switches," The Quarterly Journal of Economics, Oxford University Press, vol. 114(3), pages 869-905.
- Hernan Moscoso Boedo & Pablo D'Erasmo, 2013.
"Intangibles and Endogenous Firm Volatility over the Business Cycle,"
2013 Meeting Papers
97, Society for Economic Dynamics.
- 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.
- repec:pri:cepsud:234kaplan is not listed on IDEAS
- 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.
- 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.
- 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.
- Bachmann, Ruediger & Bayer, Christian, 2009. "Firm-specific productivity risk over the business cycle: facts and aggregate implications," Discussion Paper Series 1: Economic Studies 2009,15, Deutsche Bundesbank, Research Centre.
- Ruediger Bachmann & Christian Bayer, 2009. "Firm-Specific Productivity Risk over the Business Cycle: Facts and Aggregate Implications," CESifo Working Paper Series 2844, CESifo Group Munich.
- Chamley, Christophe & Gale, Douglas, 1994.
"Information Revelation and Strategic Delay in a Model of Investment,"
Econometric Society, vol. 62(5), pages 1065-85, September.
- Gale, D. & Chamley, C., 1992. "Information Revelation and Strategic Delay in a Model of Investment," Papers 10, Boston University - Department of Economics.
- Abhijit V. Banerjee, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, Oxford University Press, vol. 107(3), pages 797-817.
- Andrew Caplin & John Leahy, 1993. "Sectoral Shocks, Learning, and Aggregate Fluctuations," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 777-794.
When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:19973. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.