Public investment and regional business cycle fluctuations in Japan

This article examines the relationship between public investment and regional business cycle fluctuations in Japan. In particular, we focus on the effects of ‘discretionary’ changes in public investment, a portion of investment unrelated to the current state of macroeconomic circumstances. The empirical results show that such portions of public investment amplify regional business cycle fluctuations.     

MONEY, CREDIT, AND BUSINESS CYCLE COMOVEMENT

Abstract.  We developed a two-sector general equilibrium model with money and credit to study cross-sector comovement over the business cycle. Through a working capital channel, both money and productivity shocks can generate procyclicality of sectoral activities and positive cross-sector correlations of output, employment and investment. In our model, firms in each sector borrow in the credit market to finance their purchase of labour inputs, part of which are used in the adjustment process of capital stock. The shocks affect sectoral employment and investment through their impacts on interest rates and external finance premia.     

Liquidity, infinite horizons and macroeconomic fluctuations

This paper develops a computable dynamic general equilibrium model in which corporate demand for liquidity is endogenously determined. In the model, liquidity demand is motivated by moral hazard, as in Holmström and Tirole (J. Politic. Econom. 106 (1998) 1). As a result of incorporating agency cost and endogenously determined liquidity demand, the model can replicate an empirical business cycle fact, the hump-shaped dynamic response of output, which is seldom observed in standard RBC dynamics. Further, in the model the corporate demand for liquidity from a financial intermediary (credit line, for instance) is pro-cyclical, while the degree of liquidity dependence (defined as liquidity demand divided by corporate investment) is counter-cyclical. These business cycle patterns are consistent with a stylized fact empirically verified in the lending view literature.     

Financial market participation and the developing country business cycle

I explore the implications of limited participation in financial markets on a standard small open economy business cycle model. Despite its parsimony, the limited participation model developed in this paper improves over the standard model in terms of explaining two important features of business cycle facts of developing countries: high volatility of consumption, and high negative correlation between the trade balance and output. Limited participation model is then used to inspect the effects of financial development and integration on macroeconomic volatility. Under a standard calibration, limited participation model leads to the conclusion that financial development and integration are associated with higher investment and output volatility. Effect of more participation on consumption volatility is dependent on the specification of the risk premium function.     

Indeterminacy with no-income-effect preferences and sector-specific externalities

We examine a two-sector real business cycle (RBC) model with sector-specific externalities in which household utility exhibits no income effect on the demand for leisure. Unlike in the one-sector counterpart, indeterminacy can result with sufficiently high returns-to-scale in the investment sector. Moreover, the smaller the labor supply elasticity, the lower the level of externalities needed for indeterminacy. This finding is the opposite of that in all existing RBC-based indeterminacy studies. Finally, in contrast to previous sunspot-driven two-sector RBC models, our economy is able to match the stylized facts that sectoral labor inputs are positively correlated and consumption is procyclical.     

Investment-specific shocks and external balances in a small open economy model

Abstract.  We set up a standard small open economy business cycle model driven by government spending shocks, neutral productivity (TFP) shocks, and investment-specific shocks. The model is calibrated to quarterly Canadian data and its predicted moments and sample paths are compared with their Canadian counterparts. We find that the model captures the dynamics in investment and in the trade balance better than special cases of the model where either one of the productivity shocks is omitted. More specifically, the model matches the variance of the trade balance-output ratio, its correlation with output and its autocorrelation. It also matches the output-investment correlation.     

Foreign direct investment and business cycle co-movements: The panel data evidence

The previous literature has largely overlooked the possible channels through which foreign direct investment (FDI) might influence business cycle synchronization. In this study we analyze the linkages that exist among FDI, trade and industrial dissimilarity in relation to business cycle co-movements using a panel data set taken from 77 pairs of developed countries. The error component three-stage least squares (EC3SLS) estimates from a simultaneous equations model with panel data are shown to be superior to the estimates obtained from single equation models or simultaneous equations models with cross-sectional data. Our results indicate that FDI serves as a channel of international business cycle transmission that is equally important as the channels of trade and monetary policy. On the contrary, industrial dissimilarity is identified as having an indirect impact on the business cycle correlation through trade and FDI. Furthermore, our findings suggest that in our sample FDI is of the horizontal type and tends to substitute for trade.     

Investment-specific shocks and real business cycles in emerging economies: Evidence from Brazil

This paper investigates the role of the RBC (Real Business Cycle) model with investment-specific technology shocks in explaining business cycle fluctuations in Brazil. I consider the role of transitory and permanent components of neutral and investment-specific technology shocks. I fit the model to the data using Bayesian techniques to show that the investment-specific shocks are important sources of fluctuations in the estimated model. In fact, in the context of the model, investment-specific shocks can account for remarkable percentages of fluctuations in consumption growth, GDP growth, investment growth and trade balance to GDP ratio. Furthermore, I present simulation evidence showing that the RBC model cannot account for some important features of the data.     

The shrinking endogeneity of optimum currency areas criteria: Evidence from the European Monetary Union—A beta regression approach

The endogeneity of optimum currency area criteria has been widely studied. Literature suggests the existence of a positive relationship between trade intensity and business cycle correlation. Using a beta regression model for the Eurozone we have concluded that trade has a decreasing marginal effect on business cycle correlation.     

Financial cycle and business cycle: An empirical analysis based on the data from the U.S

In this paper, we first study the relationship between the financial cycle and the business cycle in the time and frequency domain. Then we also explore the interactions and dynamic mechanisms of the financial cycle, the business cycle, real interest rate and exchange rate by the VAR model. The empirical results show that the financial cycle is closely related to the business cycle, especially at medium-term frequencies (8–30 years), the business cycle leads the financial cycle with a high positive correlation. However, the relationship between them is not significant during the Great Moderation at business-cycle (2–4 years). In addition, the financial cycle not only becomes a main driver of real interest rate, the financial cycle and the business cycle, but also serves as an important source of the business cycle fluctuations. In general, our results lay some theoretical foundation for the policy practice of financial and economic stability.     

Accounting for the business cycle: Nominal rigidities, factor heterogeneity, and Austrian capital theory

An Austrian interpretation of the New Keynesian small menu cost model of the business cycle is proposed. Austrian and New Keynesian business cycle theories share the feature that the cycle is generated by rigidities which prevent the economy from adapting instantaneously to changing conditions. Austrian business cycle theory is capital-based, focusing on credit expansion which artificially lowers interest rates and causes an investment boom and unsustainable business expansion. In contrast, the New Keynesian small menu cost model of the business cycle is based on nominal rigidities which prevent markets from clearing. Small menu costs introduce dichotomous behavior, where firms find it locally optimal to avoid instantaneous output price adjustments in the face of the cost, but this local optimum results in economy-wide output and employment fluctuations which are much greater in relative magnitude. The small menu cost model of the business cycle is extended and reinterpreted in light of Austrian business cycle theory with heterogeneous, multiply-specific capital, thus providing a rigorous formalization of the Austrian business cycle. The Austrian interpretation of this New Keynesian model fortuitously addresses several of its shortcomings. JEL classification B53, E12, E23, E32     

Microeconomic uncertainty and macroeconomic indeterminacy

We propose a stylized intertemporal macroeconomic model wherein the combination of decentralized trading and microeconomic uncertainty (taking the form of privately observed and uninsured idiosyncratic shocks) creates an information problem between agents and generates indeterminacy of the macroeconomic equilibrium. For a given value of the economic fundamentals, the economy admits a continuum of equilibria that can be indexed by the sales expectations of firms at the time of investment. The Walrasian equilibrium is one of these possible equilibria but it is reached only if firms are optimistic enough. With a weaker degree of optimism, equilibrium output, employment and real wages will be lower than in the Walrasian equilibrium. Moreover, the range of possible equilibria will depend positively on the wage elasticity of the labour supply and on the magnitude of the information problem between buyers and sellers (in our case, the variance of the idiosyncratic shocks).Stochastic simulations performed on a calibrated version of the model show that pure demand expectation shocks may generate business cycle statistics that are not inconsistent with the observed ones.     

On the role of money in a business cycle model of a small open economy: The case of Spain

This paper examines the consequences of introducing a cash-in-advance constraint into a small open economy business cycle model for the Spanish case. A business cycle model is built extending Correia, Neves and Rebelo's (1995) small open economy framework and Cooley and Hansen's (1995) monetary economy. Money is introduced through a cash-in-advance constraint. The stochastic simulation of the model and its comparison to Spanish data show that the model is able to mimic i) the Dolado et al. puzzle, that is, the high volatility of private consumption for this economy; ii) the Dunlop-Tarshis observation, i.e., the negative correlation between real wages and hours worked; and iii) some cyclical features of the nominal dimension.     

Agency costs and business cycles

Summary. This paper develops a model with endogenous agency costs that is otherwise quite similar to the canonical real business cycle model. The traditional assumption in the literature is that these agency costs arise in the production of investment goods. In contrast, this paper assumes that these costs are all encompassing in the sense that they arise in the production of aggregate output. The paper explores both the importance of the investment vs. output assumption for business cycle dynamics, and the conditions under which these agency models can deliver amplification and/or persistence. The paper has two principal conclusions. First, in terms of amplification and propagation, the output model performs worse than does the investment model. This arises because a variable distortion in the investment market has more of an impact than a comparable distortion in the output market. Second, in this model with optimal consumption choice by entrepreneurs, there is a clear tension between amplification and persistence. Received: December 30, 1997; revised version: April 1, 1998     

Fear itself: How risk sensitive firms can give demand shocks bite

Many economists believe that recessions arise when aggregate demand is insufficient to support full employment. However, replicating this intuition within a real business cycle (RBC) model has proven surprisingly challenging. Rather than eliciting a contraction, lower consumer demand leads to greater household savings in many such models, fueling new investment and causing the economy to expand. The present paper proposes a novel way to resolve this apparent paradox: risk-averse firms. In the model to follow, cautious firms reduce their demand for investment prior to a recession. This contraction in the demand for capital overcomes the increased supply arising from consumer savings and restores intuitive business cycle behavior. In particular, the paper demonstrates that the model economy contracts when subjected to an uncertainty shock in consumer demand, mimicking a pre-recessionary environment in which firms, fearing a lack of orders, precipitate the downturn by reducing capital expenditures. These results are consistent with microeconomic evidence that uncertainty, particularly uncertainty about future demand, is the primary reason for firms shedding workers or scaling down operations in advance of an economic downturn. More generally, they imply that firm's attitudes towards risk shouldn't be ignored in modern macroeconomic models.     

What is the Real Story for Interest Rate Volatility?

What is the source of interest rate volatility? Why do low interest rates precede business cycle booms? Most observers tend to assume that monetary policy is largely responsible for it. Indeed, a standard real business cycle model delivers rather small fluctuations in real interest rates. Here, however, we present two models of the real business cycle variety, in which the fluctuations of real rates are of similar magnitude as in the data, while simultaneously matching salient business cycle facts. The second model also replicates the cyclical behavior of real interest rates. The models build on recent work by Danthine and Donaldson, Jermann, and Boldrin, Christiano and Fisher. We assume that there are workers and capital owners. The first model posits habit formation and adjustment costs to the stock of capital. The second model assumes that it takes time to plan investment and time to build capital.     

Basel II procyclicality: The case of South Africa

This paper studies the impact of bank capital regulation on business cycle fluctuations. In particular, we study the procyclical nature of Basel II claimed in the literature. To do so, we adopt the Bernanke et al. (1999) “financial accelerator” model (BGG), to which we augment a banking sector. We first study the impact of a negative shock to entrepreneurs' net worth and a positive monetary policy shock on business cycle fluctuations. We then look at the impact of a negative net worth shock on business cycle fluctuations when the minimum capital requirement increases from 8 percent to 12 percent. Our comparison studies between the augmented BGG model with Basel I bank regulation and the one with Basel II bank regulation suggest that, in the presence of credit market frictions and bank capital regulation, the liquidity premium effect further amplifies the financial accelerator effect through the external finance premium channel, which, in turn, contributes to the amplification of Basel II procyclicality. Moreover, under Basel II bank regulation, in response to a negative net worth shock, the liquidity premium and the external finance premium rise much more if the minimum bank capital requirement increases, which, in turn, amplify the response of real variables. Finally, small adjustments in monetary policy can result in stronger response in the real economy, in the presence of Basel II bank regulation in particular, which is undesirable.     

Measuring business cycles: A temporal disaggregation model with regime switching

In this paper, we propose a temporal disaggregation model with regime switches to disaggregate U.S. quarterly GDP into monthly figures. Alternative to the existing literature, our model is able to capture the nonlinear behaviors of both aggregated and disaggregated output series as well as the asymmetric nature of business cycle phases. To demonstrate the applicability of the proposed model, we apply the model with a Markov trend component to U.S. quarterly real GDP. The results suggest that the combination of a temporal disaggregation model with Markov switches leads to a successful representation of the data relative to the existing literature. Also, the inferred probabilities of unobserved states are clearly in close agreement with the NBER reference cycle on a monthly basis, which highlights the importance of nonlinearities in business cycle.     

Fluctuations in convex models of endogenous growth, II: Business cycle properties

Using ideas from the endogenous growth literature, we present a model of the endogenous determination of productivity growth based on individual worker decisions about human capital investment. We calibrate a version of the model to match long run growth facts from the US and study the business cycle properties of this model. This approach offers improvements along several dimensions over standard exogenous growth methodologies. Most importantly, our stochastic endogenous growth model generates much greater serial correlation in output growth and labor supply volatility relative to its real business cycle counterpart. We conclude that using the extra discipline of reproducing the trend productivity growth features of the data endogenously constitutes an important missing component from the real business cycle approach.