Creative Destruction and Uncertainty over the Business Cycle∗

Recessions are associated with increases in uncertainty. This paper shows that a simple model of creative destruction, in which new productive businesses push out old obsolete ones, produces increases in measured uncertainty during recessionary periods even without time-variation in second moments of exogenous shocks. Moreover, the suggested channel is also borne out by the data. Using an established identification strategy within a structural vector autoregression, this paper documents that several popular measures of uncertainty increase significantly in response to creative destruction shocks. This suggests that variation in measured uncertainty is (at least partly) and endogenous response of the economy to “standard” first-moment shocks.