R&D Uncertainty and Cycles

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. We 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-19. 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.