Business cycles, investment shocks, and the "Barro-King curse"

Working paper

Recent empirical evidence identfies investment shocks as key driving forces behind business cycle fluctuations. However, existing New Keynesian models emphasizing these shocks counterfactually imply a negative unconditional correlation between consumption growth and investment growth, a weak positive unconditional correlation between consumption growth and output growth and anomalous profiles of cross-correlations involving consumption growth. These anomalies arise because of a short-run contractionary effect a positive investment shock on consumption. Such counterfactual co-movements are typical of the "Barro-King curse" (Barro and King 1984), wherein models with a real business cycle core must rely on technology shocks to account for the observed co-movement among output, consumption, investment, and hours. We show that two realistic additions to an otherwise standard medium scale New Keynesian model - namely, roundabout production and real per capita output growth stemming from trend growth in neutral and investment-specific technologies - can break the Barro-King curse and provide a more accurate account of unconditional business cycle comovements more generally. These two features substantially magnify the effects of neutral technology and investment shocks on aggregate fluctuations and generate a rise of consumption on impact of a positive investment shock.

Authors: Ascari, G; Phaneuf, L; Sims, E

• Publication status: Published
• Publisher: University of Oxford
• Series: Department of Economics Discussion Paper Series
• Publication date: 2016-12-14
• Paper number: 815
• Keywords: trend inflation; wage and price contracting; business cycle comovements; investment shocks; trend output growth; standard household preferences; intermediate inputs; monopolistic competition