Investment Shocks: Sources of Fluctuations in Small Open Economy

Akande, Emmanuel (2013): Investment Shocks: Sources of Fluctuations in Small Open Economy. Published in: Economic and Business Review , Vol. 15, No. 3 (October 2013): pp. 213-232.

Abstract

This paper contributes to the existing Real Business Cycle (RBC) literature by introducing Marginal Efficiency of Investment (MEI) shocks into small open economic model. Investment shocks are the most important drivers of business cycle fluctuations in small open economy because the fluctuations in all the macroeconomic variables showed a significant response to MEI shocks than productivity shocks. The anticipation of pro-cyclical behavior of the external accounts when the model was augmented with the form of share of consumption in the household utility function, μ, and an appealing, but complex, concave adjustment cost function becomes a standpoint that differentiates this study from other investment shocks literatures. The pattern of the rise in investment in both shocks explains why investment shocks is so important in times of recession and it reveals the main source of fluctuations in a small open economy.

• Item Type: MPRA Paper
• Language: English
• Keywords: Real Business Cycle, Marginal Efficiency of Investment, productivity shocks, adjustment cost.
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E37 - Forecasting and Simulation: Models and Applications; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance

References

Barro, R. J. & R. G. King (1984). Time-Separable Preference and Intertemporal- Substitution Models of Business Cycles. Quarterly Journal of Economics, 99 (4), 817-839.

Cook, D. & Devereux, M. (2000). The macroeconomic effects on international financial panics. mimeo, University of British Columbia.

Fisher, J. D. M. (2005). The Dynamic Eects of Neutral and Investment-Specic Technology Shocks, mimeo, Federal Reserve Bank of Chicago.

Greenwood, J., Hercowitz, Z. & Krusell, P. (2000). The role of investment- specific technological change in the business cycle. European Economic Review, 44 (1), 91-115.

Greenwood, J., Hercowitz, Z. & Huffman, G. W. (1988). Investment capacity utilization, and the real business cycle. The American Economic Review, 78, 402-417.

Justiniano, A., Primiceri, G. E. & Tambalotti, A. (2008). Investment Shocks and Business Cycles, CEPR Discussion Papers 6739, C.E.P.R. Discussion Papers.

Justiniano, A., Primiceri, G. & Tambalotti, A. (2011). Investment shocks and the relative price of investment. Review of Economic Dynamics, 14 (1), 101-121.

Kydland, F. E. & Prescott, E. C (1982). Time to build and aggregate fluctuations. Econometrica, 50, 1345-70.

MaCurdy, T. (1981). An Empirical Investigation of Labor Supply in a Life-Cycle Setting. Journal of Political Economy, 89, 1059-85.

McCallum, B. T. (1989). Real Business Cycle Models. In Barro, R. J. (Ed.), Modern Business Cycle Theory. Cambridge: Harvard University Press.

Mendoza, E. G. (1991). Real business cycles in small open economy. The American Economic Review, 81:797818.

Mendoza, E. (1995). The terms of trade, the real exchange rate, and economic fluctuations. International Economic Review, 36, 101-137.

Obstfeld, M. (1981). Macroeconomic policy, exchange rate dynamics and optimal asset accumulation. Journal of Political Economy, 89, 1142-1161.

Obstfeld, M. (1990). Intertemporal dependence, impatience, and dynamics. Journal of Monetary Economics, 26, 4575.

Prescott, E. C. (1986). Theory Ahead of Business Cycle Measurement. Carnegie-Rochester Conference Series on Public Policy, 25, 11-44

Schmitt-Grohe, S. & Uribe, M. (2008). Whats News in Business Cycles, mimeo, Columbia University.

Schmitt-Grohe, S. & Uribe, M. (2003). Closing the small open economy model. Journal of International Economics, 61, 163-185.

Uribe, M. (1997). Exchange rate based inflation stabilization: the initial real effects of credible plans. Journal of Monetary Economics, 39, 197-221.

Uzawa, H. (1968). Time preference, the consumption function and optimum asset holdings. In Wolfe,J.N. (Ed.), Value, Capital and Growth: Papers in Honor of Sir John Hicks (pp. 485-504). Edinburgh: The University of Edinburgh Press.