TIME-VARYING UNCERTAINTY AND THECREDIT CHANNEL

We extend the Carlstrom and Fuerst (American Economic Review,1997, 87, pp. 893–910) agency cost model of business cycles by includingtime-varying uncertainty in the technology shocks that affectcapital production. We first demonstrate that standard linearizationmethods can be used to solve the model yet second moments enter theeconomy’s equilibrium policy functions.We then demonstrate that anincrease in uncertainty causes, ceteris paribus, a fall in investmentsupply. We also show that persistence of uncertainty affects bothquantitatively and qualitatively the behaviour of the economy....