Uncertainty shocks and the relative price of investment goods

Abstract

This study empirically shows that higher uncertainty leads to not only a simultaneous drop in consumption and investment, but also a rise in the relative price of investment goods. This negative relationship between the relative price and quantity of investment suggests that heightened uncertainty depresses investment as an adverse supply shock to the investment sector. We demonstrate that a two-sector sticky price model with realistic asymmetric sectoral price rigidity can successfully account for our empirical findings. In particular, the underlying mechanism behind the negative relationship between the price and quantity of investment is limited intersectoral factor mobility. By contrast, the standard two-sector model featuring perfect factor mobility causes a negative co-movement between consumption and investment, contradicting the business cycle phenomenon.