R&D Uncertainty and Cycles (WP-26-16)
Nicolas Crouzet and Janice Eberly
Investment in equipment and structures is one of the most cyclical components of GDP, a fact often associated with a negative response to heightened uncertainty in recessions. R&D investment, by contrast, is only mildly procyclical. The authors show that this difference could arise because of a positive response of R&D investment to uncertainty—promoting more research, development, and experimentation—a feature of most recessions but most notably during COVID. Both effects are distinct manifestations of real options, one in which costly reversibility delays investment, and the other in which investment enhances resolution of uncertainty.