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Investment Shocks and the Comovement Problem

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  • John Tsoukala
  • Hashmat Khan

Abstract

Recent work based on sticky price-wage estimated dynamic stochastic general equilibrium (DSGE) models suggests investment shocks are the most important drivers of post-World War II US business cycles. Consumption, however, typically falls after an investment shock. This finding sits oddly with the observed business cycle co- movement where consumption, along with hours-worked and investment, moves with economic activity. We show that this comovement problem is resolved in an estimated DSGE model when (i) the cost of capital utilization is specified in terms of increased depreciation of capital, as originally proposed by Greenwood et al. (1988) in a neo- classical setting, or (ii) there is no wealth effect on labor supply. The data, however, favours the first channel. Traditionally, the cost of utilization is specified in terms of forgone consumption following Christiano et al. (2005), who studied the effects of monetary policy shocks. The alternative specification we consider has two additional implications relative to the traditional one: (i) it has a substantially better t with the data and (ii) the contribution of investment shocks to the variance of consumption is over three times larger. The contributions to output, investment, and hours, are also relatively higher, suggesting that these shocks may be quantitatively even more important than previous estimates based on the traditional specification.

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Paper provided by University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM) in its series Discussion Papers with number 10/09.

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Handle: RePEc:not:notcfc:10/09

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Keywords: Investment shocks; comovement; estimated DSGE models.;

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  1. Jesús Fernández-Villaverde, 2009. "The Econometrics of DSGE Models," PIER Working Paper Archive, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania 09-008, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  2. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc.
  3. Justiniano, Alejandro & Primiceri, Giorgio E. & Tambalotti, Andrea, 2008. "Investment Shocks and Business Cycles," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6739, C.E.P.R. Discussion Papers.
  4. Frank Smets & Rafael Wouters, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," American Economic Review, American Economic Association, American Economic Association, vol. 97(3), pages 586-606, June.
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  9. Fransesco Furlanetto & Martin Seneca, 2010. "Investment-specific technology shocks and consumption," Economics, Department of Economics, Central bank of Iceland wp49, Department of Economics, Central bank of Iceland.
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  11. Robert J. Barro & Robert G. King, 1982. "Time-Separable Preference and Intertemporal-Substitution Models of Business Cycles," NBER Working Papers 0888, National Bureau of Economic Research, Inc.
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  14. Zheng Liu, 2009. "Sources of the Great Moderation: Shocks, Frictions, or Monetary Policy?," 2009 Meeting Papers, Society for Economic Dynamics 379, Society for Economic Dynamics.
  15. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research, National Bank of Belgium 35, National Bank of Belgium.
  16. Stefano Eusepi & Bruce Preston, 2009. "Labor supply heterogeneity and macroeconomic comovement," Staff Reports, Federal Reserve Bank of New York 399, Federal Reserve Bank of New York.
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Cited by:
  1. Francesco Furlanetto & Martin Seneca, 2011. "New perspectives on depreciation shocks as a source of business cycle fluctuations," Working Paper, Norges Bank 2011/02, Norges Bank.
  2. Hashmat Khan & John Tsoukalas, 2009. "The Quantitative Importance of News Shocks in Estimated DSGE Models," Carleton Economic Papers, Carleton University, Department of Economics 09-07, Carleton University, Department of Economics, revised 22 May 2012.
  3. Dey, Jaya, 2014. "Evaluating monetary policy under preferences with zero wealth effect: A Bayesian approach," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 38(C), pages 209-234.
  4. Dimitris Papageorgiou, 2014. "BoGGEM: a dynamic stochastic general equilibrium model for policy simulations," Working Papers, Bank of Greece 182, Bank of Greece.
  5. Giorgio E. Primiceri & Andrea Tambalotti & Alejandro Justiniano, 2009. "Investment Shocks and the Relative Price of Investment," 2009 Meeting Papers, Society for Economic Dynamics 686, Society for Economic Dynamics.
  6. Furlanetto, Francesco & Natvik, Gisle J. & Seneca, Martin, 2013. "Investment shocks and macroeconomic co-movement," Journal of Macroeconomics, Elsevier, Elsevier, vol. 37(C), pages 208-216.
  7. Naohisa Hirakata & Takushi Kurozumi, 2013. "The International Finance Multiplier in Business Cycle Fluctuations," IMES Discussion Paper Series, Institute for Monetary and Economic Studies, Bank of Japan 13-E-12, Institute for Monetary and Economic Studies, Bank of Japan.
  8. Marco Centoni & Gianluca Cubadda, 2011. "Modelling comovements of economic time series: a selective survey," Statistica, Department of Statistics, University of Bologna, Department of Statistics, University of Bologna, vol. 71(2), pages 267-294.
  9. Reza, Abeer, 2014. "Consumption response to investment shocks under financial frictions," Economics Letters, Elsevier, Elsevier, vol. 123(1), pages 50-53.
  10. Sohei Kaihatsu & Takushi Kurozumi, 2014. "Sources of Business Fluctuations: Financial or Technology Shocks?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(2), pages 224-242, April.
  11. Furlanetto, Francesco & Seneca, Martin, 2014. "Investment shocks and consumption," European Economic Review, Elsevier, Elsevier, vol. 66(C), pages 111-126.
  12. Marcel Förster, 2013. "The Great Moderation: Inventories, Shocks or Monetary Policy?," MAGKS Papers on Economics, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung) 201348, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  13. Görtz, Christoph & Tsoukalas, John, 2011. "News and Financial Intermediation in Aggregate Fluctuations," MPRA Paper 34113, University Library of Munich, Germany, revised Oct 2011.

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