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: Suggested Citation
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