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Financial frictions and the role of investment specific technology shocks in the business cycle

  • Gunes Kamber
  • Christie Smith
  • Christoph Thoenissen

Various papers have identified shocks to investment as major drivers of output, investment, hours, and interest rates. These investment shocks have been linked to financial frictions because financial markets are instrumental in transforming consumption goods into installed capital. However, the importance of investment shocks is not robust once we explicitly account for a simple financial friction. We estimate a medium scale dynamic stochastic general equilibrium model with collateral constraints. When entrepreneurs are subject to binding collateral constraints, a reduction in the value of installed capital reduces the value of collateral and thus the amount an entrepreneur can borrow. As a result, aggregate consumption no longer co-moves with GDP and the response of investment to a positive investment shock is attenuated. In the model with collateral constraints, the role of risk premium shocks in the business cycle increases markedly, whereas investment shocks have a much diminished role.

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Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 201206.

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Date of creation: 08 Jun 2012
Date of revision:
Handle: RePEc:san:cdmawp:1206
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  1. Giorgio E. Primiceri & Andrea Tambalotti & Alejandro Justiniano, 2009. "Investment Shocks and the Relative Price of Investment," 2009 Meeting Papers 686, Society for Economic Dynamics.
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  8. Charles Nolan & Christoph Thoenissen, 2008. "Financial shocks and the US business cycle," CDMA Working Paper Series 200810, Centre for Dynamic Macroeconomic Analysis.
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  10. Andrea Gerali & Stefano Neri & Luca Sessa & Federico M. Signoretti, 2010. "Credit and banking in a DSGE model of the euro area," Temi di discussione (Economic working papers) 740, Bank of Italy, Economic Research and International Relations Area.
  11. Matteo Iacoviello, 2002. "House prices, borrowing constraints and monetary policy in the business cycle," Boston College Working Papers in Economics 542, Boston College Department of Economics, revised 06 Dec 2004.
  12. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
  13. 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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