Financial frictions and uncertainty shocks

Abstract This paper examines how credit constraints shape the transmission of uncertainty shocks in business cycles. Standard models struggle to capture the simultaneous declines in output, consumption, investment, and labor hours during uncertainty spikes. We introduce collateral-based credit constraints for impatient households and entrepreneurs, linking their borrowing capacity to asset values. As uncertainty rises, higher risk premia reduce the demand for collateral assets, prompting impatient households to cut labor supply, leading to an output decline. Our model generates macroeconomic co-movements without relying on nominal rigidities. Lowering the loan-to-value (LTV) ratio, particularly for households, helps mitigate these adverse effects.