DP11296 Creative Destruction and Uncertainty

Author(s): Petr Sedlacek
Publication Date: May 2016
Keyword(s): Business Cycles, creative destruction, uncertainty
JEL(s): D22, D80, E32
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=11296

Recessions are times of high uncertainty. But does uncertainty cause downturns or vice versa? This paper argues that counter-cyclical fluctuations in uncertainty are, to a large extent, a natural result of creative destruction. I show analytically how aggregate growth and firm-level uncertainty are linked when firms gradually adopt a leading technology: expansions of the technological frontier widen the dispersion of firm-level productivity shocks, a benchmark measure of uncertainty. In a model of endogenous firm dynamics a technological expansion spurs a creative destruction process generating a temporary downturn and rendering uncertainty counter-cyclical. These predictions are confirmed in U.S. data showing that creative destruction accounts for 20 to 40 percent of overall variation in firm-level uncertainty.