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Volatility and growth: Credit constraints and the composition of investment

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  • Aghion, Philippe
  • Angeletos, George-Marios
  • Banerjee, Abhijit
  • Manova, Kalina
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    Abstract

    This paper examines how uncertainty and credit constraints affect the cyclical composition of investment and thereby volatility and growth. We develop a model where ï¬rms engage in two types of investment: a short-term one; and a long-term one, which contributes more to productivity growth. Because it takes longer to complete, long-term investment has a relatively less cyclical return; but it also has a higher liquidity risk. The ï¬rst effect ensures that the share of long-term investment to total investment is countercyclical when ï¬nancial markets are perfect; the second implies that this share may turn procyclical when ï¬rms face tight credit constraints. The contribution of the paper is thus to identify a novel propagation mechanism: through its effect on the cyclical composition of investment, tighter credit can lead to both higher volatility and lower mean growth. Evidence from a panel of countries provides support for the model’s key predictions.

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    File URL: http://dash.harvard.edu/bitstream/handle/1/12490636/Volatility%20and%20Growth%20-%20Credit%20Constraints%20and%20Productivity-Enhancing%20Investment%20.pdf
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    Bibliographic Info

    Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 12490636.

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    Date of creation: 2010
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    Publication status: Published in Journal of Monetary Economics
    Handle: RePEc:hrv:faseco:12490636

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    1. Robert G. King & Sergio T. Rebelo, 1989. "Transitional Dynamics and Economic Growth in the Neoclassical Model," NBER Working Papers 3185, National Bureau of Economic Research, Inc.
    2. Ricardo J. Caballero & Mohamad L. Hammour, 1991. "The Cleansing Effect of Recessions," NBER Working Papers 3922, National Bureau of Economic Research, Inc.
    3. Acemoglu, Daron & Zilibotti, Fabrizio, 1996. "Was Prometheus Unbound by Chance? Risk, Diversification and Growth," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1426, C.E.P.R. Discussion Papers.
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    9. Philippe Aghion & Philippe Askenazy & Nicolas Berman & Gilbert Cette & Laurent Eymard, 2008. "Credit constraints and the cyclicality of R&D investment: Evidence from France," PSE Working Papers halshs-00586744, HAL.
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    13. Banerjee, Abhijit V & Newman, Andrew F, 1993. "Occupational Choice and the Process of Development," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 101(2), pages 274-98, April.
    14. Garey Ramey & Valerie A. Ramey, 1994. "Cross-Country Evidence on the Link Between Volatility and Growth," NBER Working Papers 4959, National Bureau of Economic Research, Inc.
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    19. Larry E. Jones & Rodolfo E. Manuelli & Ennio Stacchetti, 1999. "Technology (and Policy) Shocks in Models of Endogenous Growth," NBER Working Papers 7063, National Bureau of Economic Research, Inc.
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    22. Barro, Robert J & Lee, Jong Wha, 1996. "International Measures of Schooling Years and Schooling Quality," American Economic Review, American Economic Association, American Economic Association, vol. 86(2), pages 218-23, May.
    23. Philippe Aghion & David Hemous & Enisse Kharroubi, 2009. "Credit Constraints, Cyclical Fiscal Policy and Industry Growth," NBER Working Papers 15119, National Bureau of Economic Research, Inc.
    24. Patrick Francois & Huw Lloyd-Ellis, 2003. "Animal Spirits Through Creative Destruction," American Economic Review, American Economic Association, American Economic Association, vol. 93(3), pages 530-550, June.
    25. Aghion, Philippe & Saint-Paul, Gilles, 1998. "VIRTUES OF BAD TIMES Interaction Between Productivity Growth and Economic Fluctuations," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 2(03), pages 322-344, September.
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    27. George-Marios Angeletos, 2007. "Uninsured Idiosyncratic Investment Risk and Aggregate Saving," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(1), pages 1-30, January.
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