Cyclical Uncertainty, Precautionary Saving and Economic Growth

Abstract

This paper studies the interaction between cyclical uncertainty, precautionary saving and economic growth in a stochastic endogenous growth model. The analysis provides insight into the potential connection between technological uncertainty of the sort popularized in real business cycle models and the determinants of economic growth in a stochastic version of a popular model of endogenously determined economic growth. The magnitude of the link between cyclical uncertainty and growth is quantified and found to be small in terms of its effect on the growth rate, but possibly large in terms of its effect on levels of macroeconomic variables. Moreover, the welfare costs of reduced cyclical uncertainty can be substantial, owing to the lower historical rate of capital accumulation induced by a decrease in precautionary saving. The chief implications of the model are found to be roughly consistent with the postwar experience of several countries, although the predictions of the model with regard to growth rates are too small to explain much of the variation in growth rates across time or across countries.