Demand shocks generate endogenous uncertainty over business cycle
A Federal Reserve working paper examines how consumer credit shocks drive endogenous uncertainty and amplify business cycles. The study uses U.S. firm-level data to quantify uncertainty as an economic propagation mechanism.
Customer traffic and capacity
The study develops a general equilibrium incomplete-markets model where heterogeneous firms face idiosyncratic demand uncertainty and aggregate consumer credit shocks.
Changes in aggregate credit alter not only expected firm demand but also the cross-sectional dispersion of sales per worker by shifting the probability that firms operate at capacity.
Consequently, first-moment credit shocks generate second-moment dispersion effects.
The framework uses U.S. Compustat data and proprietary customer traffic data to discipline the model parameters, reproducing countercyclical dispersion in firm outcomes over the business cycle.
Quantifying the amplification effect
Quantitatively, endogenous uncertainty accounts for approximately one quarter of the aggregate output response and one-third of the employment response following consumer credit shocks.
A one percent negative credit shock leads to output and employment losses of around 0.8 and 0.6 percent respectively.
These findings demonstrate that uncertainty acts as an endogenous propagation mechanism rather than merely an independent impulse, amplifying economic downturns through risk-averse firm behavior and input pre-commitments.
Endogenous risk reshapes macro theory
The study bridges the gap between exogenous uncertainty and macroeconomic fluctuations.
By linking customer traffic to aggregate credit, it provides a compelling explanation for countercyclical volatility.
Yet, reliance on proprietary micro-data limits the replicability of these findings.
Source: Demand Shocks and Endogenous Uncertainty
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