A Role Of Credit Channel And Uncetainty On Housing And Business Cycle

We consider the role uncertainty in incomplete markets environment that includes housing sector. Frictions such as poorly functioning rental and mortgage markets are likely important in accounting for cross-sectional issues such as life-cycle consumption and savings patterns. To incorporate some of the aforementioned frictions, we extend the Carlstrom and Fuerst (1997) agency cost model of business cycles by including time varying uncertainty in the technology shocks that affect housing and home capital production (in the setting of Davis and Heathcote (2005)). We first demonstrate that standard linearization methods can be used to solve the model yet second moment effects still influence equilibrium characteristics. The effects of the persistence of uncertainty are then analyzed. Our primary findings fall into four categories. First, it is demonstrated that uncertainty affects the level of the steady-state of the economy so that welfare analyses of uncertainty that focus entirely on the variability of output (or consumption) will understate the true costs of uncertainty. A second key result is that time varying uncertainty results in countercyclical bankruptcy rates - a finding which is consistent with the data and opposite the result in Carlstrom and Fuerst. Third, we show that persistence of uncertainty affects both quantitatively and qualitatively the behavior of the U.S. housing stylized facts: In particular, we show that the percentage standard deviation of residential investment is more than twice that of non-residential investment. Our model can also account for important features of industry-level data. In particular, hours and output in all industries are positively correlated, and are most volatile in construction. Finally, we find evidence for time-varying uncertainty in industry level productivity growth; however, the shocks to uncertainty imply a quantitatively small role for uncertainty over the housing and business cycle.