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Macroeconomic uncertainty and private investment in developing countries - an empirical investigation

  • Serven, Luis

The impact of uncertainty on investment has attracted considerable attention in the analytical and empirical macroeconomic literature. In theory, however, uncertainty can affect investment through different channels, some of which operate in mutually opposing direction. So, the sigh of its overall effect is ambiguous and can be assessed only empirically. To thoroughly assess the impact of macroeconomic uncertainty on private investment, the author uses a large panel data set on developing countries. He draws a distinction between sample variability and uncertainty, constructs alternative measure of the volatility of innovations to five key macroeconomic variables (inflation, growth, the terms of trade, the real exchange rate, and the price of capital goods), and examines their association with aggregate private investment. He then adds these constructed measures to an empirical investment equation that is estimated using alternative panel data econometric methods, allowing for simultaneity, country-specific effects, and parameter heterogeneity across countries. The results underscore the robustness of the link between investment and uncertainty. Virtually all of the volatility measures in the paper show a strong negative association with investment ratios. In addition, the regression estimates indicate that uncertainty has an adverse direct impact on investment, over and above any indirect effect that might also be at work. This finding is particularly robust in the case of real exchange rate volatility, which invariably has a robust negative effect on investment, regardless of econometric specification.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2035.

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Date of creation: 31 Dec 1998
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Handle: RePEc:wbk:wbrwps:2035
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