Firm Uncertainty Cycles and the Propagation of Nominal Shocks

Authors: Isaac Baley and Julio A. Blanco

American Economic Journal: Macroeconomics, Vol. 11 , No 1, 276-337 , January, 2019

We develop a framework to study the impact of idiosyncratic uncertainty on aggregate economic outcomes. Agents learn about idiosyncratic characteristics, which receive infrequent, large, and per- sistent shocks. In this environment, idiosyncratic uncertainty moves in cycles, fluctuating between periods of high and low uncertainty; with additional fixed adjustment costs, the frequency and size of agents’ actions also fluctuates in cycles. We apply our framework to study pricing behavior and the propagation of nominal shocks. We show, analytically and quantitatively, that idiosyncratic uncertainty cycles amplify the real effects of nominal shocks, by generating cross-sectional dispersion in firms’ adjustment frequencies and in learning speeds.

This paper originally appeared as Barcelona GSE Working Paper 918