Uncertainty, Irreversibility, Durable Consumption and the Great Depression

What was the role of uncertainty in the Great Depression? This paper uses a calibrated general equilibrium model to show that, in response to an increase in uncertainty, agents "increase" expenditure on irreversible durable goods and reduce investment in irreversible physical capital. These relative movements occur because durable goods provide a store of utility and are less irreversible than physical capital. These substitutions are unclear at the start of the Great Depression but are clearly visible at the deep end of it in 1932, when the volatility of stock returns is consistently high. Copyright (c) The London School of Economics and Political Science 2008.