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International business cycles and the relative price of investment goods

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  • Parantap Basu

    ()

  • Christoph Thoenissen

    ()

Abstract

Is the relative price of investment goods a good proxy for investment frictions? We model this relative price in a flexible price international economy with two fundamental shocks, namely the total factor productivity (TFP) shock and the investment specific technology (IST) shock. The paper argues that the one-to-one correspondence between investment friction and the relative price of investment goods breaks down in an international economy because of the short run correlation between the terms of trade and the relative price of investment goods. The data congruent negative correlation between the investment rate and the relative price of investment goods thus does not necessarily reflect decline in investment frictions (rise in IST) as suggested by many studies. A calibration experiment with the US data demonstrates that such an inverse relation between rate of investment and the relative price of investment goods basically reflects the positive effect of TFP on the terms of trade for a broad range of econ mies where the home bias in consumption exceeds investment and there is a sizable adjustment cost of investment. A regression experiment with major OECD countries provided empirical support of the fact that terms of trade effect on the relative price of investment is important

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Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 200905.

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Date of creation: 15 Sep 2009
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Handle: RePEc:san:cdmawp:0905

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Keywords: Investment frictions; investment specific technological progress; total factor productivity; relative price of investment goods terms of trade;

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  1. Heathcote, Jonathan & Perri, Fabrizio, 2002. "Financial autarky and international business cycles," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 601-627, April.
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  7. Martin Boileau, 1999. "Trade in Capital Goods and Investment-Specific Technical Change," Cahiers de recherche CREFE / CREFE Working Papers 68, CREFE, Université du Québec à Montréal.
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  10. Greenwood, J. & Hercowitz, Z. & Krusell, P., 1998. "The Role of Investment-Specific Technological Change in the Business Cycle," RCER Working Papers 449, University of Rochester - Center for Economic Research (RCER).
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Cited by:
  1. Gunes Kamber & Christoph Thoenissen, 2011. "Financial intermediation and the internationalbusiness cycle: The case of small countries with big banks," CAMA Working Papers 2011-22, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  2. Punnoose Jacob & Gert Peersman, 2012. "Dissecting the dynamics of the US trade balance in an estimated equilibrium model," Working Paper Research 226, National Bank of Belgium.
  3. Nadav Ben Zeev & Hashmat U. Khan, 2012. "Investment-Specific News Shocks and U.S. Business Cycles," Carleton Economic Papers 12-05, Carleton University, Department of Economics, revised 25 Feb 2013.
  4. Dmitriev, Alexandre & Roberts, Ivan, 2013. "The cost of adjustment: On comovement between the trade balance and the terms of trade," Economic Modelling, Elsevier, vol. 35(C), pages 689-700.
  5. Dey, Jaya, 2013. "The role of investment-specific technology shocks in driving international business cycles: a bayesian approach," MPRA Paper 57803, University Library of Munich, Germany, revised 06 Aug 2014.

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