Adjustment Costs or Financial Frictions?

34 Pages Posted: 25 Sep 2011 Last revised: 15 Dec 2011

Date Written: October 1, 2011

Abstract

Investment adjustment costs which depend on a change in investment serve as internal propagation mechanisms and constitute one of the building blocks of dynamic stochastic general equilibrium models. In this paper I show that certain financial frictions play a nearly observationally equivalent role to the adjustment costs in a real business cycle framework. Using both counterfactual simulations and Bayesian techniques, I compare a financial frictions model with an adjustment costs model. I find, on the one hand, that both the models fit U.S. data nearly equally well and explain key empirical facts. On the other hand, the financial frictions serve as stronger amplification mechanisms than do the adjustment costs. The result suggests that the financial frictions are favored over the adjustment costs.

Keywords: financial frictions, adjustment costs, real business cycle models

JEL Classification: E32, E44

Suggested Citation

Ikeda, Daisuke, Adjustment Costs or Financial Frictions? (October 1, 2011). Available at SSRN: https://ssrn.com/abstract=1932979 or http://dx.doi.org/10.2139/ssrn.1932979

Daisuke Ikeda (Contact Author)

Bank of Japan ( email )

2-1-1, Hongoku-cho
Nihonbashi
Chuo-ku, Tokyo, 103-8660
Japan

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