Credit Market Frictions with Costly Capital Reallocation as a Propagation Mechanism

Empirical evidence suggests that capital separation is an important phenomenon over and beyond depreciation and that reallocation is a costly and time-consuming process. In addition, both separation and reallocation rates display substantial variation over the business cycle. We build a dynamic general equilibrium model where capital separation occurs endogenously because of credit constraints and capital (re)allocation is costly due to search frictions and capital specificity. Compared to the frictionless counterpart but also compared to models of financial frictions without costly capital reallocation, our model matches surprisingly well the persistence in U.S. output growth. Furthermore, our model implies that productive capital stocks vary more than reported in the data, which has the potential to substantially reduce the volatility of technology shocks inferred from the Solow residual