Does price uncertainly really reduce private investment? A small model applied to Chile

The recent literature emphasizes the negative impact of price uncertainly on private investment as result of a higher risk premium-the price to wait. This paper argues that the uncertainly concerning the cost of capital should be compared with uncertainly in the price of output. Using a simple analytical model, we conclude that the efficiency of policies aimed to reduce the price of capital, or the basic accelator between investment and output growth, may be enhanced if(1)the volatility of the output price is greater than the volatility of the cost of capital,and(2)there is a positive correlation between changes in the cost of capital prices. In both cases, private investment will be more responsive beacuse firms will minimize profit flutuations. In the second part of the paper, the model is applied to the case of chile over the 1980–90 period. This country has earned earned the reputation of being the ‘sucess story’ of Structural adjustment and has acheived fairly stable growth in the past eight years.