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Volatility and growth: Credit constraints and the composition of investment

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

How does uncertainty and credit constraints affect the cyclical composition of investment and thereby volatility and growth? This paper addresses this question within a model where firms 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 first effect ensures that the share of long-term investment to total investment is countercyclical when financial markets are perfect; the second implies that this share may turn procyclical when firms face tight credit constraints. A novel propagation mechanism thus emerges: 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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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 57 (2010)
Issue (Month): 3 (April)
Pages: 246-265

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Handle: RePEc:eee:moneco:v:57:y:2010:i:3:p:246-265
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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