Real Rigidities and the Propagation of Uncertainty Shocks

This paper studies how strategic complementarities generated by real rigidities affect the propagation of uncertainty shocks. The focus here is on two commonly featured forms of pricing complementarities that result at the firm level, in particular from i) decreasing returns to scale or the presence of firm-specific inputs (within the class of constant elasticity demand functions), ii)Kimball-type aggregator (within the class of demand functions with state-dependent elasticities). While the two mechanisms have qualitatively similar implications to first-order, their effects on the propagation mechanism of uncertainty shocks are cardinally different. In particular, firm-specific inputs strengthen the contractionary impact of uncertainty shocks by amplifying the upward pricing channel. With the Kimbal aggregator, on the contrary, firms bias their pricing decision downward, generating an expansionary effect of heightened uncertainty on economic activity.