The Finance Uncertainty Multiplier
We show how real and financial frictions amplify the impact of uncertainty shocks. We build a model with real frictions, and find adding financial frictions roughly doubles the impact of uncertainty shocks. Higher uncertainty alongside financial frictions induces the standard real-options effects on investment and hiring, but also leads firms to hoard cash, further reducing investment and hiring. We then test the model using a panel of US firms and a novel instrumentation strategy for uncertainty exploiting differential firm exposure to exchange rate and price volatility. These results highlight why in periods with greater financial frictions uncertainty can be particularly damaging.
We would like to thank our formal discussants Nicolas Crouzet, Ian Dew-Becker, Simon Gilchrist, Po-Hsuan Hsu, Howard Kung, Gill Segal, Toni Whited, and the seminar audiences at the Adam Smith Conference, AEA, AFA, Beijing University, BI Norwegian Business School, CEIBS, Econometric Society, European Finance Association, Macro Finance Society Workshop, Melbourne Institute Macroeconomic Policy Meetings, Midwest Finance Association, Minneapolis Fed, NY Fed, Society for Nonlinear Dynamics and Econometrics, Stanford, The Ohio State University, UBC Summer Finance Conference, University College London, University of North Carolina at Chapel Hill, University of St. Andrews, University of Texas at Austin, University of Texas at Dallas, University of Toronto, Utah Winter Finance Conference, World Congress. The NSF and Alfred Sloan Foundation kindly provided research support. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.