Uncertainty over business conditions and investment: Evidence from Japanese firms

In recent years, advanced economies have experienced uncertainty shocks repeatedly, such as the Global Crisis, the Eurozone Crisis, and the ‘fiscal cliff' in the United States (in 2012). The Japanese economy has been affected not only by these global events, but also by shocks specific to Japan including the transfer of political power between the Liberal Democratic Party and the Democratic Party (2009, 2012) and the 2011 Great East Japan Earthquake. Using data from a quarterly business survey in Japan, we construct a measure of business uncertainty and analyse the time-series properties of uncertainty and its relationship with investments.

Theoretically, because of the irreversibility and adjustment costs of investment, economic uncertainty has a negative effect on investment. This mechanism is referred to as the option value of waiting. Empirical studies generally support this theoretical prediction that uncertainty has a negative impact on equipment investment, research and development (R&D) investment, and hiring of employees. In the empirical studies, various proxies of uncertainty have been developed and employed, such as volatility of stock prices, the unexplained portion of macroeconomic variables derived from econometric models, the cross-sectional disagreement of economic forecasts, or the frequency of newspaper articles regarding uncertainty (see Bloom 2014 and Jurado et al. 2015, for surveys).

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