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Stochastic Business Cycle Volatilities, Capital Accumulation and Economic Growth: Lessons from the Global Credit Market Crisis

Author

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  • Kwamie Dunbar

    (University of Connecticut and Sacred Heart University)

Abstract

The recent global economic downturn in a number of economies was preceded by rising credit market risk brought on by a massive financial market failure. This paper develops a small open economy model that analyzes the interaction of business cycle volatilities with capital accumulation and the subsequent impacts on economic growth. We use a stochastic dynamic programming model to test the central hypothesis that rising volatility shocks is an inhibitor to capital accumulation and subsequently economic growth. The model illustrates that traditional capital-based growth models which assume a constant capital stock are not consistent with the business cycle variation in capital accumulation. Furthermore, it appears that an increase in precautionary savings arising from a stochastic shock does not completely translate into productive capital investment need for growth, since risk-averse households will seek out risk-free government or foreign assets. We find this conclusion consistent with the empirical findings of Ramey et al (1995) and Badinger (2009) who both argued that, business cycle volatility is important to the growth discussion because of its robust net negative effect on output growth.

Suggested Citation

  • Kwamie Dunbar, 2009. "Stochastic Business Cycle Volatilities, Capital Accumulation and Economic Growth: Lessons from the Global Credit Market Crisis," Working papers 2009-36, University of Connecticut, Department of Economics.
  • Handle: RePEc:uct:uconnp:2009-36
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    References listed on IDEAS

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    Cited by:

    1. Robert Feicht & Wolfgang Stummer, 2010. "Complete Closed-form Solution to a Stochastic Growth Model and Corresponding Speed of Economic Recovery preliminary," DEGIT Conference Papers c015_041, DEGIT, Dynamics, Economic Growth, and International Trade.

    More about this item

    Keywords

    Economic Growth; Capital Accumulation; Business Cycle Volatilities; Stochastic Optimal Control; Economic Contraction; Credit Default Swaps; Credit Crisis; Credit Markets;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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