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Investment Shocks and the Comovement Problem

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 comovement 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 the cost of capital utilization is specified in terms of increased depreciation of capital, as originally proposed by Greenwood et al. (1988) in a neoclassical setting. 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 speci cation we consider has two additional implications relative to the traditional one: (i) it has a substantially better fit 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 Carleton University, Department of Economics in its series Carleton Economic Papers with number 09-09.

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Length: 30 pages
Date of creation: 21 Oct 2009
Date of revision: 09 Aug 2010
Publication status: Published: Revised version in Journal of Economic Dynamics and Control, Vol. 35, No. 1 (January 2011), pp. 115–130
Handle: RePEc:car:carecp:09-09
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  1. An, Sungbae & Schorfheide, Frank, 2005. "Bayesian Analysis of DSGE Models," CEPR Discussion Papers 5207, C.E.P.R. Discussion Papers.
  2. Zheng Liu & Daniel F. Waggoner & Tao Zha, 2009. "Sources of the Great Moderation: shocks, friction, or monetary policy?," Working Paper Series 2009-01, Federal Reserve Bank of San Francisco.
  3. Jesús Fernández-Villaverde, 2010. "The econometrics of DSGE models," SERIEs, Spanish Economic Association, vol. 1(1), pages 3-49, March.
  4. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper Series WP-01-08, Federal Reserve Bank of Chicago.
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  9. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
  10. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  11. Miles S. Kimball & Michael Woodford, 1994. "The quantitative analysis of the basic neomonetarist model," Proceedings, Federal Reserve Bank of Cleveland, pages 1241-1289.
  12. Justiniano, Alejandro & Primiceri, Giorgio E & Tambalotti, Andrea, 2008. "Investment Shocks and Business Cycles," CEPR Discussion Papers 6739, C.E.P.R. Discussion Papers.
  13. Barro, Robert J & King, Robert G, 1984. "Time-separable Preferences and Intertemporal-Substitution Models of Business Cycles," The Quarterly Journal of Economics, MIT Press, vol. 99(4), pages 817-39, November.
  14. Stefano Eusepi & Bruce Preston, 2009. "Labor Supply Heterogeneity and Macroeconomic Co-movement," NBER Working Papers 15561, National Bureau of Economic Research, Inc.
  15. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research 35, National Bank of Belgium.
  16. Fransesco Furlanetto & Martin Seneca, 2010. "Investment-specific technology shocks and consumption," Economics wp49, Department of Economics, Central bank of Iceland.
  17. Sungbae An & Frank Schorfheide, 2007. "Bayesian Analysis of DSGE Models—Rejoinder," Econometric Reviews, Taylor & Francis Journals, vol. 26(2-4), pages 211-219.
  18. Smets, Frank & Wouters, Raf, 2007. "Shocks and frictions in US business cycles: a Bayesian DSGE approach," Working Paper Series 0722, European Central Bank.
  19. Jonas D. M. Fisher, 2006. "The Dynamic Effects of Neutral and Investment-Specific Technology Shocks," Journal of Political Economy, University of Chicago Press, vol. 114(3), pages 413-451, June.
  20. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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