Investment and demand uncertainty

This paper investigates the effects of uncertainty on the investment decisi ons of a sample of Italian manufacturing firms, using information on the su bjective probability distribution of future demand for firms' products acco rding to the entrepreneurs. The results support the view that uncertainty w eakens the response of investment to demand thus slowing down capital accum ulation. Consistent with the predictions of the theory, there is considerab le heterogeneity in the effect of uncertainty on investment: it is stronger for firms that cannot easily reverse investment decisions and for those wi th substantial market power. We show that the negative effect of uncertaint y on investment cannot be explained by uncertainty proxying for liquidity c onstraints.