From Average Demand to Endogenous Uncertainty

The subject here is the quantitative judgment at the center of the consumer-credit model: how much of a firm and aggregate response comes from lower or higher average demand, and how much comes from the accompanying change in demand risk. The timing, capacity ceiling, and risk-sensitive hiring decision now fit together well enough to ask that question directly. The answer matters because it determines whether firm-level uncertainty is merely a symptom of a downturn or an additional mechanism that amplifies it.

The Federal Reserve study’s central contribution is not to replace the ordinary demand channel with an uncertainty story. It is to show that the two channels can be generated by the same credit movement. A credit improvement raises expected customer spending. At the same time, the capacity margin can compress the distribution of sales per worker, making the next hiring commitment less risky. A tightening reverses both effects. The model therefore treats uncertainty as endogenous: it responds to the state of demand and then feeds back into firms’ choices.

One credit shock, two margins of adjustment

Start with the direct level effect. When aggregate consumer credit improves, customers can command more resources during the shopping stage. A firm expects higher sales per worker, so the expected revenue from labor rises. That makes hiring more attractive even before considering the distribution of possible customer matches. When credit tightens, expected sales per worker fall and the direct reason to expand employment weakens.

Now add the distributional effect. Because sales per worker cannot exceed productive capacity, better customer purchasing power pushes more realizations toward a common ceiling. The relevant dispersion falls. For a risk-averse owner, the marginal worker is now evaluated over a less threatening range of possible sales. A tightening leaves more of the firm’s outcome dependent on whether enough customers happen to arrive, so the wage commitment carries greater downside risk. The direct and distributional effects point in the same direction, but they are conceptually different.

The model’s impulse response gives the combined result a concrete scale. A positive one-percent innovation to aggregate credit raises output by about 0.8 percent on impact and employment by roughly 0.6 percent. Sales per worker rises by approximately 0.18 percent. The difference is important: much of the output response comes from firms demanding more labor, rather than from a large increase in output produced by each worker. The credit condition changes the expected return to operating at a larger scale.

The model also reports that demand uncertainty falls by close to eight percent on impact after the positive credit innovation. The share of firms operating at the per-worker capacity ceiling rises by roughly 2.2 percentage points. Those movements clarify why capacity is the hinge.