Uncertainty Shocks, Innovation, and Productivity

Abstract

In this paper, we argue that macroeconomic uncertainty shocks cause a persistent decline in economic activity, investment in R&D, and total factor productivity. After providing empirical evidence, we build a DSGE model with sticky prices and endogenous growth through investment in R&D. In this framework, uncertainty shocks lead to a short-term fall in demand because of precautionary savings and rising markups. The reduction in the utilised aggregate stock of R&D determines a fall in productivity, which causes a long-term reduction in the main macroeconomic aggregates. When households feature Epstein-Zin preferences, they become averse to these long-term risks affecting their consumption process (long-run risk channel), which severely exacerbates the precautionary savings motive and the overall adverse effects of uncertainty shocks.