DP6739 Investment Shocks and Business Cycles

Author(s): Alejandro Justiniano , Giorgio E Primiceri , Andrea Tambalotti

Publication Date: March 2008

Keyword(s): Bayesian , DSGE model , endogenous markups , imperfect competition

JEL(s): C11 , E30

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6739.asp.asp

Shocks to the marginal efficiency of investment are the most important drivers of business cycle fluctuations in US output and hours. Moreover, these disturbances drive prices higher in expansions, like a textbook demand shock. We reach these conclusions by estimating a DSGE model with several shocks and frictions. We also find that neutral technology shocks are not negligible, but their share in the variance of output is only around 25 percent, and even lower for hours. Labour supply shocks explain a large fraction of the variation of hours at very low frequencies, but not over the business cycle. Finally, we show that imperfect competition and, to a lesser extent, technological frictions are the key to the transmission of investment shocks in the model.